PSTG - Pure Storage: Storing Value In Data Innovation 18x FCF

2023-10-02 04:50:36 ET

Summary

• Pure Storage's near-term prospects focus on simplifying and modernizing data storage with offerings like Evergreen//One.
• Evergreen//One offers a storage-as-a-service (STaaS) model based on actual usage, potentially leading to increased costs with higher usage.
• Pure Storage's valuation is reasonable, with a forward price-to-free cash flow multiple of around 18x.
• The company's strong balance sheet provides flexibility for future growth and strategic initiatives.

Investment Thesis

Pure Storage (PSTG) is known for its all-flash storage solutions. Their core offering centers around high-performance, all-flash arrays designed for various workloads, including mission-critical applications. Pure Storage emphasizes simplicity and efficiency in data storage.

I make the case that paying approximately 18x forward free cash flows is reasonable. Yes, there are some minor pesky detractions to this investment thesis, but overall there are a lot more positives than negatives when it comes to this stock.

Pure Storage's Near-Term Prospects

Pure Storage is a leader in data storage and management, specializing in delivering innovative data storage solutions. Their mission is to simplify how people consume and interact with data, focusing on three major market trends: the adoption of the cloud operating model, the increase in modern cloud-native applications, and the shift to modernizing data infrastructure with all-flash technology.

Pure Storage offers a range of products and subscription services that support structured and unstructured data across a hybrid cloud environment.

Their technology is centered around flash-based systems and highly integrated software and hardware, providing top performance, reliability, and cost-efficiency.

As you'd imagine this space is highly competitive. Not an exhaustive list by any stretch, but here are two competitors worth highlighting. NetApp ( NTAP ) provides comprehensive data management services and hybrid cloud solutions (read more ) while Nutanix ( NTNX ) specializes in hyper-converged infrastructure for data management (read more ).

Moving on, Pure Storage's near-term prospects are driven by its strategic focus on simplifying and modernizing data storage solutions. That being said, part of Pure Storage's growth strategy is to offer products such as Evergreen//One product suite.

Pure Storage's Evergreen//One platform seeks to streamline customers' data storage and management processes while delivering customers a STaaS business model (storage as a service). Put another way, Pure Storage's Evergreen//One doesn't truly operate on a subscription basis. Rather, they charge customers to access Pure Storage's solutions as a service. In plain English this model charges for actual usage, it's a consumption-based model.

In my experience, I've not found many success stories for companies that charge more per usage. While this type of business model sounds enticing, what happens is that customers are charged more, the more they use the platform. And by the nature of that, it curtails future usage, as nobody likes to be left with an unexpected bill at the end of a period.

To be clear, this is not a deal breaker, but it is a pesky detraction that readers should be attentive to.

Revenue Growth Rates Moderate, What's Next?

The graphic above reminds readers that this business is no longer in hyper-growth mode. That's understandable, given that the business is now coming close to being 15 years old which, in the tech industry, is a pretty long time. Particularly when we consider that Pure Storage is ultimately offering a somewhat commoditized storage solution.

That being said, I believe that if Pure Storage can continue to grow at around 13% to 15% CAGR, that means there's still substantial steam left in the tank.

What's more, followers of my work will know that I believe the customer adoption curve is often the most insightful aspect when it comes to appraising the underlying health of a business.

What you see here is that, with time, customers seeking out Pure Storage are still increasing, and were up 14% y/y in fiscal Q2 2024. And this again aligns with its underlying revenue growth rates.

Indecently, note that I'm a big believer that it's much better for a company's growth rates to be supported by an increase in customers, rather than relying on pricing hikes, because you can only increase the price so high, after which, new competitors will start to take market share way.

Moreover, as you can see below from Pure Storage's NPS scores, the business is clearly doing something right.

Not only is its NPS score above 70, which is often viewed as a high benchmark, but there's also a steady stream of customers reaching out for its offering.

Considering all of these factors, let's shift our focus to examine its valuation.

PSTG Stock Valuation -- Reasonable Entry Point

Pure Storage's multiple has expanded of late, but it's far from stretched at less than 4x forward sales.

More concretely, I estimate that the business is probably going to make around $600 million of free cash flow over the next twelve months. This puts the stock priced at approximately 18x forward free cash flows. A multiple that I don't believe is stretched at all, particularly as we consider that nearly 9% of its market cap is made up of net cash.

Indeed, Pure Storage's strong balance sheet provides the business with a lot of flexibility. Yes, Pure Storage has some share repurchases ongoing, but frankly speaking, these repurchases are not strong enough to meaningfully impact the dilution associated with management's stock-based compensation.

On the other hand, Pure Storage's strong balance sheet ends up providing Pure Storage with flexibility and future options on how to best grow its intrinsic value.

The Bottom Line

Pure Storage is known for its high-performance, all-flash storage solutions that focus on simplicity and efficiency in data storage. Its near-term prospects appear promising, with a strategic focus on simplifying and modernizing data storage solutions.

Evergreen//One aims to streamline data storage and management processes while adopting a storage-as-a-service (STaaS) business model, allowing customers to pay based on actual usage. However, the consumption-based pricing model might pose some challenges, as it can lead to higher costs with increased usage, potentially discouraging customers.

While Pure Storage is no longer in hyper-growth mode, with revenue growth rates moderating, it continues to show steady customer adoption, indicating underlying growth potential.

In terms of valuation, Pure Storage appears reasonably priced at approximately 18x forward free cash flows. Further, its strong balance sheet provides flexibility for future growth.

Despite some minor concerns, Pure Storage's focus on innovative data storage solutions and its ability to adapt to evolving market trends position it as an intriguing prospect in the data storage industry.

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