The enterprise-software industry has grown rapidly in recent years. It has been less affected by trade tensions than the hardware sector, where growth has slowed as tariffs take hold. Software companies also tend to be scalable, meaning that as revenue increases they can improve profit margins with little incremental cost.
The acknowledgement that software automation creates efficiencies and economies of scale has boosted demand for corresponding technology services. One of these is cloud computing, which helps provide a solution to one of the most pressing business challenges: managing and storing data.
Since its inception in 1999, Salesforce has been a leader in customer relationship management (CRM) software. The US-based company offers multiple cloud products and accounts for 17% of the CRM market by revenue, three times the share of its next competitor.
We have held a position in Salesforce since the middle of 2018. We think it has strong fundamentals, including a history of turning a profit, solid growth prospects, good corporate behaviour and positive sentiment surrounding it (see figure 1).
Figure 1: The Alpha Model views Salesforce as sound
Source: Hermes, for illustrative purposes only, as at June 2019.
Revenue growth has been strong across all business areas, including cloud products and the Salesforce platform. The latest earnings results were particularly strong – revenue rose by 24% on a year earlier, while operating cash flow grew by 34% year-on-year to reach $1.97bn. Earnings sentiment is also positive: Salesforce raised its earnings-per-share forecast for 2020 to $2.88-$2.90, beating analyst expectations of $2.66.
Figure 2: Back on track
Source: Refinitiv, as at August 2019.
No clouds on the horizon
Salesforce’s plan to acquire data-analytics firm Tableau shows its management team is focused on future opportunities. Analysts reacted cautiously to the news – some are worried about how Salesforce will integrate the business. We think that Salesforce’s expansion over the past five years means it will be capable.
Up until now, Salesforce has focused on providing CRM software. Tableau will increase its exposure to data analytics and help diversify its business model. This could bolster sales and bring Salesforce into direct competition with Microsoft and Oracle, which both offer business-intelligence tools, as well as Google, which recently announced it was buying data-analytics firm Looker.
Salesforce is also expanding overseas. Over the past few years it has signed partnership agreements with Amazon and Google, which have enabled it to develop its international operations. More recently, it also joined forces with Alibaba, which should help it take advantage of China’s booming cloud-computing sector.
The software industry is a competitive and rapidly changing space, but we think that Salesforce has the potential to succeed. It has solid goals which include aiming to double revenue over the next four years, while its focus on customer relationships and overall experience should help support earnings going forward.
Salesforce is working to minimise its impact on the environment. A quarter of its revenue is aligned to Sustainable Development Goals seven (affordable and clean energy) and 13 (climate action). It recently made headlines when it achieved net-zero greenhouse-gas emissions and a carbon-neutral cloud.
The firm’s reach means that it has the power to reduce the impact that both it, as a company, and its customers have on the planet. Last year, Chief Executive Marc Benioff said he was committed to achieving 100% renewable energy for the company’s operations. Statements like this suggest that Salesforce’s commitment to mitigating the effects of climate change is credible. We believe the company provides a strong model of leadership for others to follow.
Change in the air: TCFD
As part of our analysis of Salesforce’s environmental, social and governance (ESG) characteristics, we have assessed its disclosures on areas recommended by the Task Force on Climate-related Financial Disclosures (TCFD), an initiative backed by the Financial Stability Board.
The TCFD’s recommendations aim to help companies disclose climate-related risks to investors and other stakeholders. As of July 2019, Hermes was one of 810 organisations pledging support for the TCFD.
We have focused on two TCFD recommendations: governance, as well as metrics and targets (see chart). We think that governance is particularly important as good corporate oversight tends to lead to outperformance on environmental and social factors. It is also one of the key fundamentals we assess in a company.
Figure 3: Ticking the boxes
Source: Taskforce on Climate-related Disclosures, as at July 2019.
Salesforce’s disclosures on governance address TCFD recommendations. The company says that there is oversight of climate-related issues at board level: a subcommittee of the board of directors meets regularly to review ESG issues. The bonuses of certain employees, including the Chief Philanthropy Officer, are linked to achieving environmental sustainability goals.
The company also performs well on metrics and targets. At the end of the last fiscal year, it announced it was halfway towards achieving 100% renewable energy in its data centres and offices (see box).
There is always room for improvement. While Salesforce encourages its suppliers to set emissions-reduction targets (see box), it could play an even more active role in persuading them to decarbonise. Salesforce could also disclose more details about how it does this, and in the process shed light on how it is able to use its prominent position to influence others.
Nonetheless, we are encouraged by how Salesforce has engaged with the TCFD. It is currently voluntary to follow the TCFD’s recommendations, but in 2020 the Principles for Responsible Investment will make it mandatory for signatories to report certain indicators (although it will be voluntary to disclose them).
Salesforce is leading the way with its climate-related disclosures and we think that this should support its business going forward. Establishing sound environmental policies and making use of renewable sources also mean it is better prepared for a low-carbon future with potentially higher and more volatile energy costs.
Last year, our paper ‘ESG investing: a social uprising’ concluded that companies with good or improving ESG attributes have on average outperformed those with negative characteristics. This was driven by the social and corporate governance metrics however, as environmental considerations were not shown to be statistically significant.
While we cannot prove that companies with attractive environmental characteristics deliver better returns, we have seen no evidence that they underperform either. The increased focus of company executives on environmental practices also suggests that many think that climate-related risks are integral to business performance.
As a result, we believe that investors can integrate environmental considerations into their strategies without worrying about them detracting from performance. Indeed, Salesforce’s best-practice approach to tackling environmental risks is testament to its long-term mindset, which only adds to the company’s solid fundamentals.
Data privacy and cyber security are potential headwinds for Salesforce. As the world digitalises, software companies need to be aware of tighter laws surrounding customer data – in particular, the European Union’s (EU’s) General Data Protection Regulation (GDPR). The legislation came into force last May and applies to all EU countries, meaning it will be hard for US firms not to comply with it.
The stakes are high for Salesforce: a breach of its information systems could cause reputational damage, litigation and possible action from regulators, all of which would prove costly. It is a visible target and its customers have been affected by phishing scams in the past.
Salesforce was also involved in a lawsuit in 2017, which alleged that it had processed sensitive personal information without consent (although its client, Tesla, was the primary defendant). This highlights the challenge Salesforce faces in managing its relationships throughout its supply chain.
Salesforce has responded to these controversies and implemented robust data-security initiatives, managing to avoid a major data theft or breach in recent years. It has revised its policies to reflect the requirements of GDPR and has a Global Privacy Counsel who helps ensure compliance with global rules.
We think that the comprehensive data-privacy and security-management systems Salesforce has in place means it should be able to meet increasingly exacting regulations. Ultimately, operating in line with GDPR could improve customer trust and help Salesforce win business.
Ahead of the cloud
In our view, Salesforce has strong underlying fundamentals. It leads the way in the rapidly evolving software industry and its expansion plans should help it continue to do so in the years ahead. While Salesforce faces challenges, it has responded in a timely manner to new data-privacy legislation.
Most importantly, it has reacted constructively to the greatest challenge of today – climate change. The company has demonstrated that it is willing to work to combat the effects of global warming, while encouraging its suppliers and customers to do the same. This makes Salesforce particularly well positioned to flourish in a low-carbon future.