The global economy is slowing, and the epic run-up in the value of the US dollar against other currencies is eating into the profits and profits of multinational companies. However, cloud software businesses are showing strength. Big businesses currently favor projects with a quick return on investment, and moving digital operations to the cloud delivers just those kinds of quick benefits.
To wit, Salesforce (CRM -4.99%) and Service Today (NOW -4.58%) both reported solid earnings in the second quarter despite numerous challenges. However, one of these cloud stocks looks like a better buy right now.
Salesforce: Enduring (but slowing) growth from a cloud pioneer
Salesforce has a broad portfolio of software solutions that help its clients get the most out of their customer data and transform their IT operations for the cloud. In the first half of its fiscal 2023, revenue rose 23% year over year to $15.1 billion. Free cash flow rose 12% to $3.63 billion, giving a margin of 24%.
Even in times of macroeconomic uncertainty, Salesforce’s massive toolbox is still winning over many new users. However, the company is heading for a significant slowdown in the back half of the fiscal year. Management recently lowered its guidance to forecast revenue growth of just 17%. Two main factors are to blame. First, the growing strength of the US dollar against foreign currencies lowers the value of international sales. And second, the growth Salesforce accrued from its acquisition of digital workplace communications company Slack last summer (which is expected to contribute about $1.5 billion in sales, or just shy of 5% of total revenue of Salesforce) is done.
However, the biggest news in the quarterly update Salesforce delivered on August 24, was the company’s first-ever share repurchase program. The board of directors authorized buybacks worth $10 billion. That’s about 5.8% of the company’s current market cap. Shares currently trade for 31 times enterprise value on free cash flow.
ServiceNow: A leading bet on operational efficiency
ServiceNow provides software development tools to build better digital workflows — for IT teams, for employees, and even for customer interactions in an enterprise . Automating repetitive processes (which saves money over time) is something businesses are willing to spend on today. When the economy slows, cost-cutting initiatives tend to take the spotlight, and ServiceNow solutions help in a big way.
ServiceNow’s second quarter financial report also shows that its services are in high demand. Revenue rose 25% year over year in the first half of 2022 to $3.29 billion. Free cash flow rose a very healthy 27% to $1.05 billion (32% of revenue).
But ServiceNow also expects its expansion to slow in the back half of the year. Management is now guiding for full-year subscription revenue growth of 24% and a free cash flow profit margin of 30%. Previously, it guided for 26% and 31% growth in those metrics, respectively.
Despite slightly lowering management expectations, ServiceNow is proving to be a solid cloud technology business through good times and bad. The stock currently trades at an enterprise-value-to-free-cash-flow ratio of 45.
Which is the better buy now?
Salesforce has a long history of delivering double-digit-percentage annual revenue growth, and with the completion of its big acquisition of Slack, its profit margins are on the rise again. It also has an extensive list of services that all types of organizations need as they adapt their operations for a new digital era. Of these two companies, ServiceNow is growing faster and generating slightly higher profit margins. However, its stock price carries a higher value that reflects those things.
So, the real differentiator right now may be Salesforce’s share repurchase program. Shortfalls arising from currency exchange rate headwinds and other economic factors can be mitigated by a shrinking share count, which will boost its free cash flow per share. There’s a lot to like about both of these cloud computing leaders, and I think they both have places in a well-diversified portfolio. But I think Salesforce stock is the slightly better buy at the moment because of its new plan to start returning excess cash to shareholders.
Nicholas Rossolillo and his clients have positions in Salesforce, Inc. The Motley Fool has positions and recommends Salesforce, Inc. and ServiceNow, Inc. The Motley Fool has a disclosure policy.