Morgan Stanley Downgrades salesforce.com (CRM) to Equalweight on Margin Expansion Forecast

Morgan Stanley analyst Keith Weiss downgraded Salesforce.com (NYSE: CRM) to “Equal-weight” from “Overweight” citing “lack of confidence in significant margin expansion”.

Weiss takes note of CRM’s market capitalization of about $250 billion to join tech software titans Adobe, Intuit and Microsoft. The analyst notes that “a sharper focus on EPS growth.

will likely be needed to drive shares materially higher from here.” Moreover, an emphasis on FCF is also required given the company’s current growth, scale, and market cap.

“The good news is our updated SaaS X-ray suggests Salesforce currently has the unit economics to drive operating margins to 28% in 5-years (based on our growth estimates) and 33% in 10-years, as growth slows towards 10%. The growth versus margin framework presented by Salesforce at their 2018 analyst day would support this margin trajectory as well. However, significant progress on that margin path is unlikely in our view as: 1) a rebound in demand in CY21 would likely pressure margins given the dynamics of a subscription model, and 2) Salesforce's reliance on M&A to bolster future growth potential has pushed the company away from the original growth vs. margin framework,” Weiss wrote in a note sent on Thursday.

Therefore, Morgan Stanley analyst says that the bank is unable to push the price target beyond $275 (the current price target) on balancing risk/reward at current levels.

“We are cautious on realizing significant progress on margins in the near-term given the nature of subscription models. As demand slows (like we've seen in CY20), subscription models should see good margin expansion as revenues continue to amortize off the balance sheet, reflective of the growth seen in the prior 12-months, while the company can adjust expenses in real-time in response to the environment.

“However, we expect Salesforce is likely only to report moderate margin improvements this year (+70bps). The new billings impacts seen in CY20 (we estimate down 13% YoY) and slower total billings (we estimate +17% YoY) will eventually flow into revenues, likely resulting in CY21 deceleration,” the analyst adds.

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