PSTG - Pure Storage: The Dip Presents A Good Entry Point

2023-04-12 20:13:04 ET

Summary

• PSTG's revenue growth is likely to be affected by the macro and enterprise IT spend slowdown, resulting in elongated sales cycles and increased deal scrutiny.
• However, the company's energy-efficient products and subscription offerings are expected to drive market share gains amidst the downturn.
• PSTG has a significant total addressable market of over $50 billion, including hardware and software opportunities in enterprise storage.
• I have an end-of-fiscal year 2024 price target of $33, based on a forward EV/CY24E revenue multiple of around 3.0x applied to the consensus FY2025 revenue estimate of $3.3 billion.

Thesis

Pure Storage, Inc.’s ( PSTG ) leadership in NVMe technology will help it maintain its competitive edge and leadership position in the market. The company’s software-defined all-flash data storage solutions for the enterprise have allowed it to improve the reliability of cheap consumer-grade flash with the help of software, enabling cost efficiencies and broadening flash's appeal for enterprise use. PSTG has a significant total addressable market of over $50 billion, including hardware and software opportunities in enterprise storage. I assign a buy rating to the stock with an end-of-fiscal year 2024 price target of $33, based on a forward EV/CY24E revenue multiple of around 3.0x applied to the consensus FY2025 revenue estimate of $3.3 billion.

Post FYQ423 Outlook: Macro Headwinds Affecting Growth

Pure Storage updated its revenue growth estimate for FY24 to be in the low to mid-single digits. The company attributes this to a slowdown in macro and enterprise IT spending, resulting in a slower ramp of deals in the pipeline funnel, elongated sales cycles, and increased scrutiny on deals as customers focus on cost savings in the short term. While no enterprise hardware companies are immune to the tougher macro environment, PSTG remains a share gainer due to its efficient and energy-saving product offerings, such as FlashBlade//E, FlashBlade//S, FlashArray//C, and FlashArray//XL.

Despite the macro uncertainty and elongation of sales cycles for enterprises with weakened spend, I expect PSTG's subscription offerings to remain strong amid the downturn due to cost savings and the opex model. Moreover, the company's energy-efficient products align with the ESG angle, which resonates with some customers. Management expects to achieve its FY24 OPM guide of 15% through targeted hiring and cost discipline.

Total Addressable Market

Pure Storage offers software-defined all-flash data storage solutions for the enterprise. As such, I believe it competes in both the hardware and the software side of the enterprise storage market. On the hardware side, Gartner pegs the overall external controller-based (ECB) storage market at $21.1 billion in 2020, and forecasts the market to reach $23.4 billion in 2025, with Solid-State Storage Arrays capturing about 45% or $10.7 billion of the market. Over the next decade, the market is expected to grow at a CAGR of 15.5%. While Pure’s core market is the Solid-State Array space, I believe there is a potential for it to continue to gain share in the overall ECB storage market, especially for the mid to high-range arrays, as the secular trend toward flash plays out.

The software-defined nature of Pure’s solution allows it to collapse spend in the Storage Management software market as well, which is estimated to be valued at ?$20 billion and is expected to grow at a 8.6% CAGR till 2027. The Purity operating environment at the core of its storage platform provides various capabilities such as Data protection and Recovery, Storage Replication, Storage and Device Management, Archiving, among others, thus allowing it to compete with many pure-play storage management software providers.

Leader in Solid State Arrays with Defensible Software-Based IP

Pure Storage is a leading provider of software-defined all-flash data storage solutions for the enterprise. The company has developed unique methods to improve the reliability of cheap consumer-grade flash through software, which has helped to drive cost efficiencies and encourage the mass adoption of flash in the enterprise. Pure Storage has also developed several patent-protected innovations, such as non-disruptive upgrades, superior data-reduction capability, and an easy-to-use interface, which give it a competitive edge in the market. As a result of its strong market position, Pure Storage has been recognized as the leader with the highest "completeness of vision" score in Gartner's Magic Quadrant for Solid State Arrays for four consecutive years.

The company’s success is reflected in its over 8,700+ customers, including over 30% of F500 companies, and a 65% CAGR from FY16-FY18. The company has a high Net Promoter Score (NPS) of 81.4, which is highest in the industry. The NPS represents the likelihood of customers recommending a vendor, and Pure Storage's high NPS underscores its high level of customer satisfaction.

Valuation

Pure Storage has enjoyed rapid growth in the last few years, fueled by strong new customer additions and a high repeat purchase rate. For FY18-23 (fiscal years ending in Jan), Pure’s revenue grew at 22% CAGR and settled in at 26% y/y growth for FY23. While revenue growth should decelerate due to macro headwinds, I expect the company to continue to grow at a double digit rate in the medium term.

I have an end-of-fiscal year 2024 price target of $33, which is based on a forward EV/CY24E revenue multiple of around 3.0x applied to the consensus FY2025 revenue estimate of $3.3 billion. This multiple falls between the multiples for storage companies such as NetApp, Inc. (NTAP), Seagate Technology Holdings plc (STX) and companies that offer infrastructure solutions sold in an appliance form such as Fortinet, Inc. (FTNT), Check Point Software Technologies Ltd. (CHKP), and Palo Alto Networks, Inc. (PANW).

The premium to the storage companies reflects Pure's better revenue growth trajectory and gross margin profile, while the discount to the appliance form infrastructure accounts for Pure's relatively lower growth and FCF margin profile. Although Pure Storage is classified as a hardware company, its software capabilities are its secret sauce. If Pure Storage changes its strategy and moves towards software-only sales, it could potentially see an expansion of its multiple.

Risks

Pure Storage's business momentum may be affected by the increasing adoption of cloud-based storage, even though they offer a robust hybrid cloud solution with the ability to burst into public cloud infrastructure. While Pure Storage provides a reliable hybrid cloud solution, and I expect the hybrid cloud trend to continue, the movement of workloads into public cloud infrastructure could have an impact on the company's revenue. Pure Storage's revenue is primarily generated from the sale of its hardware appliance solution, with only a small portion coming from recurring support and maintenance. This could lead to unpredictable revenue patterns and lower revenue visibility.

Final Thoughts

Pure Storage is a leading provider of software-defined all-flash data storage solutions for enterprises. It is one of the few companies that have developed software to improve the reliability of cheap consumer-grade flash, making flash storage more cost-efficient for the enterprise. Additionally, PSTG offers a maintenance program that provides significant value to customers, along with patented innovations such as non-disruptive upgrades, superior data-reduction capabilities, and an easy-to-use interface, which give it a competitive edge in the market.

Pure Storage has a large total addressable market of over $50 billion, including hardware and software opportunities in enterprise storage and its differentiated solid-state array offering positions it well to take advantage of the trend toward flash-based storage. I assign a buy rating to the PSTG stock with an end-of-fiscal year 2024 price target of $33, which is based on a forward EV/CY24E revenue multiple of around 3.0x applied to the consensus FY2025 revenue estimate of $3.3 billion.

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