Event: CRM reports its Q4 earnings tomorrow, Feb. 27th, after the close. The options market is implying about a 7.25% one day move, which is slightly below the 4 quarter average of 7.75%, but in line with the 8 quarter average of about 7.25%.
Sentiment: Wall Street analysts have been very positive on CRM throughout the past year, a period in which the stock has rallied about 56%. There are 38 buy ratings, 3 hold ratings, and 4 sell ratings on the stock. Meanwhile, short interest remains somewhat elevated, around 8.5%, though that is near its lowest level over the past year.
CRM hit a new all-time high yesterday, with a market cap now around $38 billion. The stock is up more than tenfold since its late 2008 low near $5.
Options Open Interest: Calls outnumber puts by a ratio of about 1.1 to 1 in total open interest. Calls have been more active over the past month (average one month call/put ratio of 1.5 to 1) as the stock has continually hit new all-time highs. The March 57.5 puts have the most open interest of any put line, with over 10k of open interest. The May 70 calls are the only call line with over 10k of open interest, at around 11k.
Price Action/Technicals: CRM has had two large moves higher over the past 5 years. The first was the move off of the 2008-2009 bottom, as the stock zoomed up to the $35 level by late 2010. From there, the stock was essentially flat for almost 3 years, with most of the time spent between $30 and $40 (red lines), before zooming higher again over the past 9 months:[caption id="attachment_36874" align="alignnone" width="600"] CRM weekly chart, Courtesy of Bloomberg[/caption]
The stock’s recent uptrend has been relatively steep, and the uptrend line currently stands around the $56 level:[caption id="attachment_36876" align="alignnone" width="600"] CRM daily, Courtesy of Bloomberg[/caption]
$56-$57.50 is the first significant support on the downside, while the $50 level has more long-term significance as support. With the stock at an all-time high, no resistance exists on the upside.
Fundamentals/Valuation: CRM is the type of tech growth company that is simply not our cup of tea. Many investors have made a good deal of money with this stock, but the risk/reward simply does not make sense to us. The company has grown earnings by about 50% in the past 5 years (and from a paltry base, going from about $150 million in earnings to about $225 million earnings). Meanwhile, the stock has gone up tenfold.
Granted, growth investors are focused on the future opportunity (whenever that might arrive). Sales have almost quadrupled since 2009, from a little more than $1 billion to around $4 billion today. In fact, investors in CRM are clearly focused on sales growth much more than earnings, as evidenced by the stability of the P/S multiple over the past few years:[caption id="attachment_36877" align="alignnone" width="504"] CRM Price/Sales ratio, Courtesy of Bloomberg[/caption]
This ratio has fluctuated between 6 and 11 for the better part of the last 5 years, and is near the midpoint of that range today.
Of course, we’d rather see earnings if we were investors ourselves, but market participants seem more focused on sales growth for now.
Volatility: 30 day implied volatility in CRM is approaching 45, which is right in line with its level prior to earnings over the past year:[caption id="attachment_36878" align="alignnone" width="600"] CRM 30 day implied volatility, Courtesy of Bloomberg[/caption]
In addition, the implied move for earnings is around 7%, quite close to the 4 and 8 quarter averages. In other words, implied volatility is priced in line with recent history, and looks fair.
Our View: We discussed the fundamental conundrum of the cloud enterprise software business in our Deep Dive post on WDAY. My conclusion in that post was:
More specifically, my simple take is that the overall business of cloud-based enterprise software might not be nearly as lucrative as the hype might suggest. Oracle and SAP are Workday’s biggest competitors, and you can bet that their battle for enterprise contracts is fierce. Moreover, a company like Salesforce.com (an indirect, and potential future competitor) has been a public company for almost a decade now, and though it is profitable, its profit growth has hardly been stellar (the stock price appreciation is a different story altogether). So the company’s expectation that achieving scale will lead to significant profits seems dubious.
For both WDAY and CRM, revenue growth seems to be matched by expense growth of almost equal magnitude, excluding R&D. In other words, the businesses don’t show the operating leverage I would expect this far along in its growth cycle. In CRM’s earnings report last night, gross profit for the quarter increased by $205 million, while marketing and sales expense plus the General and Administrative expense increased by around $193 million. So almost no operating profit, NOT including R&D expense.
Maybe Workday’s applications are so innovative as to blow the competition out of the water. But a human resources application that is indispensable? Somehow, I find that hard to believe.
Of course, WDAY and CRM are both much higher since I wrote that, and they could go higher given the momentum psychology. I have no position in either stock, and no plan for any new position. But I am still of the view that the stocks themselves are on quite shaky ground given their underlying earnings power.