CRM Q1 Earnings Preview and Strategy on Existing Position

by Enis May 20, 2014 11:44 am • Commentary

Event:  CRM reports its Q1 earnings today after the close.  The options market is implying about a 6.75% one day move, which is slightly below both the 4 quarter average of 7.25% and the 8 quarter average of about 7%.

Sentiment:  Wall Street analysts have remained very positive on CRM throughout 2014, even as the stock has declined 20% since its all-time high of $67 in late February. There are 38 buy ratings, 2 hold ratings, and 6 sell ratings on the stock.  Meanwhile, short interest remains somewhat elevated, around 8%, though that is near its lowest level of the past 3 years:

CRM short interest, Courtesy of Bloomberg
CRM short interest, Courtesy of Bloomberg

CRM is down 3% so far in 2014.

Options Open Interest:  Calls outnumber puts by a ratio of about 1.03 to 1.  One month average volume has also favored calls by a ratio of 1.25 to 1.  There are only a few strikes with over 6k of open interest:

-Jun21st 50 puts

-Jun21st 52.5 calls

-Jun21st 57.5 calls

-Jan15 60 calls

Price Action/Technicals:  CRM’s weekly chart shows that the stock’s decline over the past couple of months has led to its first test of the 50 week moving average since July 2013:

[caption id="attachment_40697" align="alignnone" width="600"]CRM weekly chart, Courtesy of Bloomberg CRM weekly chart, Courtesy of Bloomberg[/caption]

The $40 level is more important long-term support, as that was resistance throughout 2011 and most of 2012, and coincides with the 200 week moving average.

Zooming into the daily chart, the $55 resistance level is the key spot to watch on the upside:

[caption id="attachment_40698" align="alignnone" width="600"]CRM daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg CRM daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg[/caption]

First, CRM closed 2013 at $55.19, so that is the unchanged mark for the year on the stock.  The declining 50 day ma is now around $55, and CRM has found resistance near there over the past few weeks.  On the downside, the $47 level, marked in green, has held ever since the stock’s August earnings gap.

Fundamentals/Valuation:  We have been fundamentally bearish on CRM for some time.  Here is what I wrote in last quarter’s earnings preview:

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.

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 (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.

While SaaS is a snazzy name for the industry, the Software-as-a-Service companies have been heavy on hype, and quite light on profits.  Scalability is the buzz word as the companies continue to focus on growing sales, but with very little evidence of significant operating leverage, we’ll leave CRM and its SaaS brethren to those big on the hype rather than the bottom line.

Volatility:  30 day implied volatility spiked higher in late April when CRM broke its 200 day moving average on large volume, hitting a 1 year high:

[caption id="attachment_40699" align="alignnone" width="600"]30 day implied volatility in CRM, Courtesy of Bloomberg 30 day implied volatility in CRM, Courtesy of Bloomberg[/caption]

As the stock has stabilized in the past few weeks, implied vol has moved lower, and is now actually below 40, lower than where it has been over the past 4 earnings announcements.

Our View:  The stock is at a fairly interesting spot near term, down 20% from the all time highs made in late February just below technical resistance from last month’s breakdown.  If this report was 2 or 3 weeks ago when it seemed that no matter what the news was for high valuations stocks, they would be sold, we would be inclined to press this trade from the short side.  But the market has a slightly different tone to it over the last couple weeks, despite some fairly anemic rallies in some hard hit sectors, the SPX once again flirts with new highs. CRM puts the C in the term cult stock, and has never been an easy trade from the short side.  A couple weeks ago when CRM bounced from $50 to $53 we bought some short dated puts (here) and closed 1/2 the position for a double when the stock retreated back below $50 (here) days later. The stock seems to be grinding at the six month lows.   We are still of the mindset that rallies should be sold in these sorts of stocks, and don’t see the recent declines as a buying opportunity.  For our purposes we are not going to initiate a new short in front of the earnings, we have made our bet and took our cost off of the table. But the second half of our puts is now pretty far out of the money, the price on the sale of those equals the profits locked in on the trade. So what we’re likely to do today is see if there’s any weakness into the close and either sell those puts to lock in the trade’s profits as best we can or if it really sells off and 50 comes back into play possibly look to spread those puts.