Salesforce (NASDAQ: CRM) recently posted its Q1 results, where it boasted a significant expansion in margins and a robust outlook for Fiscal Year 2023. This development came after activist investors suddenly swarmed the stock earlier this year. The resounding message conveyed by these activists, which emphasized the untapped potential for incremental value, resonated with Salesforce’s management. In fact, the company focused precisely on this during the most recent quarter.
Despite the positive climate surrounding the stock, I feel that the recent surge in Salesforce’s stock price has already factored in a significant portion of its previously unexplored upside. Accordingly, I am switching my stance from bullish to neutral.
Probing Activist Interest in Salesforce
Salesforce has emerged as a magnet for substantial investor interest throughout this year, capturing the attention of numerous influential players in the financial landscape. The surge of attention commenced in January with the groundbreaking revelation that Elliot Management had acquired a “big stake” in Salesforce. Meanwhile, before this, in October 2022, Starboard Value, an activist investor, had already secured a “significant” stake in the company. However, it was Elliot’s bold move that triggered the domino effect that followed, enticing several other prominent funds to join the club.
Notably, in early February, Third Point, an activist hedge fund, proudly declared its stake in the company, joining the esteemed ranks of other renowned investors. And then, merely a week later, Stephen Mandel’s Lone Pine publicly disclosed its investment in Salesforce, highlighting its confidence in the company. The prestigious Point72 Asset Management, led by Steven Cohen, also boarded the bandwagon, acquiring a position in Salesforce. In addition, distinguished activist investors such as Inclusive Capital and ValueAct promptly seized the opportunity to align themselves with the surging momentum surrounding Salesforce.
The surge of activist interest in the stock can be attributed primarily to the immense potential for Salesforce to attain operational efficiencies and unlock higher levels of profitability. Numerous indicators strongly supported this notion. One such example is the ambitious objective set by Starboard’s founder, Jeff Smith, who aimed to enhance the balance between growth and profitability within Salesforce, which he deemed currently “subpar” compared to its competitors.
Shedding further light on this issue, Well Fargo analyst Michael Turrin emphasized that “the conversation surrounding Salesforce’s margins has gained significant momentum, particularly in the last three to five years,” pointing out the success of other businesses in achieving more favorable margin structures. “The intensity of this conversation has certainly picked up,” he said, according to Yahoo Finance.
Salesforce Delivered Results
It seems that Salesforce took note of activists’ thoughts, as the company didn’t just deliver robust revenue growth in Q1, but its margins and margins outlook also saw a significant boost.
For the quarter, total revenues reached a new record of $8.25 billion, up 11% year-over-year. Growth was driven by higher subscription revenues, which were in turn driven by Salesforce booking some amazing client wins, including Northwell Health, NASA, Paramount, Siemens, Spotify, as well as the U.S. Department of Agriculture, among others. It’s worth noting how impressive Salesforce’s client lineup is, as more than 90% of the Fortune 100 companies utilize it and average more than five of its clouds.
But back to our main objective: margin and profitability. This is where Salesforce positively surprised investors, delivering a stunning improvement. Following robust revenue growth and cost-cutting initiatives, Salesforce exceeded its prior margin target for the quarter by a notable margin, posting an adjusted operating margin of 27.6%.
This implies 1,000 basis points year-over-year, which is quite remarkable. Building upon this success, management also raised their margin guidance for the year. Specifically, for Fiscal Year 2024, management targets an adjusted operating margin of 28%, implying an improvement of 550 basis points year-over-year. Management also remained confident that they will hit an adjusted operating margin of 30% in Q1 2025. They even affirmed to investors that enhancing profitability is their utmost priority, leaving no room for uncertainty.
Is CRM Stock a Buy, According to Analysts?
Turning to Wall Street, Salesforce has a Moderate Buy consensus rating based on 22 Buys, nine Holds, and one Sell assigned in the past three months. At $238.40, the average Salesforce stock forecast suggests 12% upside potential.
If you’re wondering which analyst you should follow if you want to buy and sell CRM stock, the most profitable analyst covering the stock (on a one-year timeframe) is Terry Tillman from Truist Financial, with an average return of 19.13% per rating and an 85% success rate.
Takeaway: Salesforce’s Upside Looks Priced In
The surge of activist interest in Salesforce stock highlighted the untapped potential for operational efficiencies and higher profitability prospects, leading the company to post a great Q1. Besides the recent positive developments, however, it seems like that much of the stock’s upside may have already been priced into the shares.
Salesforce stock has rallied roughly 50% over the past six months and features a forward P/E of about 30. Hence, any setback in management’s targets could indeed trigger some correction. In general, it might be wise to be wary of a stock’s downside potential during times of elevated enthusiasm like the current one. Hence, my neutral rating.
