## investment thesis

sales force (NYSE: CRM) has a price-to-earnings ratio of about 550, which seems unreasonably high. To put this in perspective, Morningstar shows that the stock has a P/E ratio of just 34.This suggests investors need to dig deeper into financials When valuing a company, the project of the company should be considered, not the bottom line at face value.

A large portion of CRM costs come from depreciation and amortization charges. In my opinion, these charges are unlikely to cause any substantial financial distress, which means they should not be included in CRM’s valuation.

CRM is also undergoing a massive restructuring, which appears to be taking a large charge on its income statement. Based on historical trends, these charges appear to be non-recurring over the long term, meaning they should not be included in CRM’s valuation.

According to Morningstar, CRM’s revenue growth is expected to be 12%, which is in line with our projected free cash flow growth, implying that top-line growth is likely to filter through to its earnings and free cash flow. This shows that growth is driven by sustainable business models rather than non-operating means.

Using these growth numbers and adjusted net income as a proxy for free cash flow, I think the company is grossly undervalued.

**morning star opinion**

Morningstar’s full article describing its fair value valuation model is a paid article. We will try our best to understand based on the outline released for free.

Let’s summarize the main points of Morningstar’s valuation:

*Estimated FY2024 Financial Results*:

- “Our fair value estimate for Salesforce is $245 per share,”
- “This implies a 7x FY2024 enterprise value/sales,”
- “Adjusted P/E ratio of 34,”
- “3% free cash flow yield.”

*Projected growth through 2028:*

- We forecast a five-year CAGR of 12% in total revenue by FY2028;
- Our revenue forecast assumes a modest acceleration in revenue following subdued growth in FY2023 and FY2024.
- We expect non-GAAP operating margin to expand from 23% (real) in FY2023 to around 30% in FY2028.

## Projected “3% free cash flow yield”

According to Investopedia, the FCF yield is calculated as follows:

Morningstar expects a “free cash flow yield of 3%” and a fair value per share of “$245” in FY24 (end 2023). The company’s most recent reported “total number of common shares outstanding” was 977 million shares.

Assuming this fair value is priced as the “market price per share” of CRM, we can derive:

- Estimated free cash flow per share = 3% x $245 = $7.35.
- Estimated FCF = $7.35 x 977M = $7,180.95M.

If we tabulate historical free cash flow with Morningstar’s forecast data, we can expect CRM’s FY2024 free cash flow growth rate to be 13.75%. (assuming FCF is “cash from operations” – capex)

Recall that Morningstar expects “12% revenue growth through fiscal 2028.” This figure is very close to our calculated projected free cash flow growth rate of 13.75%. In general, I think:

- Morningstar expects CRM’s free cash flow to grow by 13.75% in fiscal 2024, primarily due to a 12% revenue growth that trickles down to its bottom line and is reflected in free cash flow.
- Since the increase in free cash flow is driven by the company’s improved sales revenue performance rather than through other non-operating means, this growth is expected to be sustainable in the long run.

## Estimated P/E Ratio 34

CRM’s P/E ratio is currently around 550, but Morningstar predicts CRM’s *Adjusted* PE is only 34.How Morningstar “adjusted” the company’s earnings for a PE of just 34 (from *huge* Chapter 550)

Recall that:

- PE=price per share/earnings per share (or EPS).
- Morningstar’s fair value (price per share) is $245.

Therefore, to achieve Morningstar’s fair value of $245, CRM would need EPS of:

- Price per share/PE=245/34= ~$7.2.

That means CRM’s “adjusted” earnings figure should be $7.2 per share. Currently, based on a PE of 550 and a share price of about $210 per share, CRM’s EPS is 210/550, or $0.38.

Therefore, the key questions to ask are:

“How CRM’s EPS went from just up$0.38 to $7.2? “

The number of outstanding shares on CRM’s balance sheet is 977 million. this means:

- EPS of $0.38 means that CRM’s latest annualized earnings are
*face value*= $0.38 x $977 million = $371.26 million. - EPS of $7.2 means CRM’s projected adjusted earnings = $7.2 x $977 million = $7,034.4 million.

Combining the above two points, we understand that although the face value of CRM’s revenue is only 371.26 million US dollars, its revenue is only 371.26 million US dollars. Morningstar Believes in CRM *deserved* Instead, it is valued based on adjusted earnings of $7,034.4 million.

Note that $7,034.4 million is projected earnings for the end of FY 2024. For now, CRM has only announced earnings for the first quarter of 2023. this means:

- Estimated $7,034.4 million
*future earnings/value*CRM (“FV”) at the end of 0.75 years (or 3 quarters).

Adding in FinBox’s 9.3% WACC (“WACC Mid”), we can calculate the present value of Morningstar’s projected future earnings:

According to PV, we learned that:

Morningstar believes the company’s valuation should be based on current earnings of $65,805,500, not $3,712,600.

Obviously, the current profit of $371.26 million is far from the expected $6,580.55 million.

so,

The next step is to look for cost items in the company’s financial statements that could reasonably be adjusted to arrive at an amount closer to $6580.55M.

**Income Statement Analysis**

We look at the CRM’s income statement to check for cost items that may be one-time and are unlikely to last in the long term:

From the income statement we learn that over the last 12 months:

- The cost of goods for CRM is relatively low, accounting for only 8B/32B=25% of total revenue.
- Operating expenses are huge, accounting for 20B/32B=63% of total revenue. These operating costs will also include the non-cash items of depreciation and amortization costs.
- The “restructuring charge” of 1.54B is relatively low, but still substantial. Based on historical trends, these costs do not appear to be recurring, so we can add them back to achieve adjusted net income.

Furthermore, if we extrapolate from the latest earnings call transcript, the CFO also assured investors that the company’s restructuring is nearing completion:

This further reinforces our belief that restructuring charges are expected to be short-lived.

**Cash Flow Analysis**

Despite an unusually low net profit, CRM’s cash flow position is very favorable and growing year over year:

In particular, we can observe 2 unusually large cost items added back to net profit to arrive at the “cash from operations” figure:

- The total depreciation and amortization cost is ($3.7 million + $2.2 million = $5.9 million). These are the result of spreading the cost of acquiring assets over an extended period of time to meet the company’s accounting obligations. As such, they are unlikely to cause any financial distress, which means adjusting back to CRM earnings is reasonable.
- Stock-based compensation (SBC) is also very large. While these are non-cash incentives designed to align the interests of executives with those of shareholders, they can have the negative impact of ownership dilution, resulting in significant loss of company value. Therefore, it should be properly reflected in the overall earnings.we should
*no*Adjust SBC back to its net profit.

**Adjusted net profit**

If we use the insights from the previous sections to adjust to calculate what we think is a reasonable net revenue CRM should be valued at, we arrive at a figure of $7.796 billion:

That number is closer to our estimate of $65,805,500 based on Morningstar’s forecast:

Still, $7796 is about 20% away from $6580.55 million. This is no surprise. We don’t know exactly which of the better assumptions Morningstar made to arrive at their view.

In my opinion, the main takeaway from this adjusted figure is that our views and assumptions may be *Generally speaking* Consistent with Morningstar’s.

**Discounted Cash Flow Valuation**

Based on the previous discussion, we will make the following assumptions/inputs in the calculation of CRM Intrinsic Value:

- In the previous sections, we discussed how starting with a forecast P/E ratio of 34 and a fair value of $245 per share, we calculated the FV of CRM’s FY2024 adjusted net income and discounted it using WACC to arrive at a cash value of $6580.55 value (FY23). As most of the adjustments have been made through the addition of substantial non-cash expenses, it is expected that the final benefit will be largely cash based.Therefore, we will use the adjusted earnings data as the
*agent*FCF for CRM by the end of 2022 (our FCF forecast begins). - Morningstar believes the annual compounding of CRM
*income*The growth rate was 12%.We assume that this revenue growth will largely filter through to its*free cash flow*2023 to 2027, before growth matures, and tapers to 3% from 2028 and beyond. - The WACC value of 9.30% is taken from the previously referenced FinBox and will be used as our discount rate.
- We assume that the company’s outstanding shares will remain unchanged at 977M indefinitely.

Based on the above assumptions, calculate the present value of projected free cash flow for each year and summarize.

Taking into account the total debt and cash held by the company, the resulting intrinsic value is approximately *$244.70 USD*.

This is comparable to Morningstar’s fair value of 245, which means analysts are likely using similar valuation models to ours.

Assuming the current market price is 210, the stock is:

(244.7 – 210) / 210=16.52% *underestimated*.

## in conclusion

CRM appears to be operating a fundamentally profitable business model with free cash flow growing at high double-digit percentages.

The company also expects to complete its workforce restructuring by the end of fiscal 2024 and its real estate restructuring by the end of fiscal 2026. Therefore, the restructuring costs currently incurred may be short-lived.

Its profits fell sharply due to the accumulation of depreciation and amortization costs. In my opinion, these costs are unlikely to affect the fundamental quality of the business and should therefore be excluded when calculating the true value of the company.

Overall, the underperformance of CRM’s financial figures is believed to be due to factors that do not have a significant impact on the quality of its business model. If these factors are removed when calculating the intrinsic value of CRM, the current market price appears to be undervalued.

Investors should consider adding more CRM positions as a long-term investment.