CRM conservatively expects AI buffs, better profits to boost valuations

$Safety (CRM)$ beat earnings expectations last quarter and the stock hasn't had a decent pullback since the spike. We mentioned last quarter: CRM's valuation has 66% room for improvement.

The market remained relatively optimistic about CRM's performance prior to the announcement of FY24 Q1 earnings, with Q1 expectations hitting full steam and a more optimistic outlook for AI-spurred results. The secondary market share price also exceeded $220 prior to the earnings report.

However, CRM executives did not want to overdraw expectations early, and while Q1 earnings results were still above expectations overall, the outlook for the rest of the year was not overly optimistic. As a result, the stock price pulled back 5% after the results came out.

Earnings Overview

Q1 revenue was $8.24 billion, up 11% year-over-year, above the market consensus of $8.17 billion, and 13% year-over-year, excluding currency movements, above the market consensus of 12%.

Broken down by business, subscription revenue of $7.64 billion grew 11 percent year-over-year, slightly above market expectations of $7.56 billion, with data services revenue of $1.96 billion beating market expectations of $1.95 billion.

Company software billings of $5.94 billion, up 11% year-over-year, rebounded to double digits for the second consecutive quarter and was in line with market expectations

Remaining performance obligations (RPO) of $46.7 billion, up 11 percent year-over-year and in line with market expectations

Software deferred revenue was $15.12 billion, up 11% year-over-year and in line with market expectations.

On the profit side, comparable EBITDA of $2.27 billion doubled 123% year-over-year, above market expectations of $2.10 billion, with an adjusted operating margin of 27.6%.

The company's free cash flow reached $4.24 billion, significantly higher than the market's estimate of $3.39 billion.

For the Q2 FY24 outlook, the company expects revenue in the range of $8.51-8.53 billion, above market expectations of $8.49 billion, and Non-GAAP earnings per share of $1.89-1.90, above market expectations of $1.71.

For the full fiscal year 2024 outlook, the company expects revenue of $34.5-$34.7 billion, with the median slightly lower than the market's estimate of $34.65 billion, and Non-GAAP EPS of $7.41-$7.43, higher than the market's estimate of $7.17.

Investment Highlights

Technology companies cope with the winter, software services are currently expected to remain conservative. Since FY23Q4 greatly exceeded expectations, analysts have raised their expectations for the company's performance, so market expectations for Q1 were hit relatively full, slightly exceeding expectations in this case, and proving the company's strength in the industry and excellent operational capabilities. Looking at several leading indicators, RPO, deferred revenue, etc. were in line with market expectations, and year-over-year growth remained in double digits, but also flat compared to the previous quarter.

Based on RPO and cRPO (current remaining performance obligation) data provided by CRM. The cRPO growth slowed to 11.8% in the fourth quarter of FY2023 compared to the 22.2% year-over-year growth in the fourth quarter of FY2022. This is due to a deceleration in current order growth, which declined to 11.2% in the fourth quarter of FY2023 compared to 21.1% year-over-year growth in the fourth quarter of FY2022. This trend has contributed to the slowdown in revenue growth. However, in the first quarter of FY2024, cRPO grew 12% year-over-year, a slight improvement from the previous quarter. In the short term, the impact of previous "cost reductions and efficiencies" in various industries may have passed, but it is important to keep an eye on the changes that will follow.

The company is conservative in its full-year expectations, especially in the second half of the year when some recession expectations are taken into account and management is more focused on profitability. Despite the recent addition of AI fever, the company is not adding that component to its own earnings outlook for now, so management is more focused on profitability than revenue growth, regardless of whether a recession will actually come. The company's margins in both quarters, as well as free cash flow, significantly exceeded market expectations, which is more in line with what shareholders want in the current environment.

The Slack acquisition will help the company become more competitive in the AI era, and Slack, the office instant messaging app Salesforce acquired in '15, will be the most promising business in the AI era. The company will add a range of generative AI features to Slack, including "SlackGPT," which can summarize messages, take notes, and even help improve the tone of messages. Back in March, the company already released Einstein GPT, adding OpenAI's generative AI technology to its own AI products.

Valuation

CRM's current TTM P/E ratio of 41x is slightly above the industry average, although since the company aims to improve margins, it may not make sense to rely solely on a TTM valuation, with future earnings per share growth much higher than TTM earnings per share.

Based on CRM's FY2024 earnings outlook, CRM's adjusted EPS is expected to reach $7.42, up 42% year-over-year. At $210, CRM's P/E ratio of 28x on FY2024 expected EPS is below the $34x of Microsoft (MSFT)$ and the software industry average of 44x.

In addition, as we mentioned previously, the company's 2023 P/S ratio of 5.9x is also below the average P/S ratio of 9.1x for large software companies. Therefore CRM is still not expensive at the moment.