SNOW - Snowflake's Turning The Tide: Reversal From Bearish To Bullish

2024-01-08 08:57:22 ET

Summary

• Snowflake shows signs of breaking its trend of decelerating revenue growth, marking a potential turning point with stabilization in fiscal Q4 2024.
• The shift in sentiment from bearish to bullish is fueled by expectations that Snowflake can achieve a consistent 30% or higher Compound Annual Growth Rate (CAGR) in the calendar year 2024.
• Overall, Snowflake is now a solid choice for investors.

Investment Thesis

Snowflake ( SNOW ) is a company that has to its back approximately 10 consecutive quarters of decelerating revenue growth rates. But as its outlook for next quarter attests to, it appears that Snowflake has finally started to stabilize its growth profile.

Therefore, as succinctly as possible, my thesis is that, looking out into the next fiscal year (calendar 2024), it seems highly likely that Snowflake can deliver higher than 30% CAGR in each quarter. This will allow Snowflake to put forth a substantially more alluring narrative than it has succeeded of late.

With a more alluring narrative and fundamentals to back said narrative, this will allow Snowflake to be viewed in a more positive light over the next 12 months.

Therefore, I no longer believe it makes sense to be bearish on this name. And I now turn bullish on this stock.

Rapid Recap

In my previous bearish analysis back in May, I said,

Investors are more than willing to pay up for a fast-growing company, with a compelling narrative, particularly if the fundamentals are moving in the right direction.

But when an expensive stock has the fundamentals moving in the wrong direction, this can leave the stock too exposed to a share price correction.

Since that time, this has been the share price performance.

Without a doubt, I made the wrong call to be bearish on this stock. The main reason why I now reverse this call is that Snowflake's prospects for the next fiscal year should be more attractive, as it won't have to endure numerous back-to-back quarters of decelerating revenue growth rates.

This is not a blemish-free investment thesis as there are still some pesky detractions that we must consider, including the obvious consideration that its valuation is already super stretched.

But I get ahead of myself. We have a lot to get through here, so let's get to it.

Snowflake's Near-Term Prospects

Snowflake is a cloud-based platform that helps companies store, manage, and analyze large amounts of data efficiently. Think of it as a high-tech warehouse for information, where businesses can securely store their data in the cloud. What makes Snowflake stand out is its ability to handle diverse types of data-whether it's structured or unstructured-and its support for advanced technologies like artificial intelligence and machine learning. This platform enables organizations to easily access and analyze their data, gaining valuable insights that can inform important business decisions. Essentially, Snowflake provides a powerful and flexible solution for managing data in the digital age.

While Snowflake's prospects appear promising, it faces challenges in the near term. The enterprise adoption of AI and machine learning presents hurdles, and Snowflake acknowledges the critical role of quality data in AI strategies.

Although Snowflake addresses the challenge through its data-sharing architecture, ensuring broad access to quality data remains a priority. Security and governance are additional obstacles to enterprise AI adoption, and Snowflake's response to this is Snowflake Horizon, offering a unified solution built for AI. Despite these advancements, the success of Snowflake's foray into AI depends on overcoming these challenges and ensuring that its customers can fully leverage the capabilities of the platform. As the company continues to introduce new capabilities, including native apps, UniStore, and Apache Iceberg Tables, managing a diverse and expanding number of "high quality" large customers may pose a challenge, which is what I seek to highlight next.

As you can see above, back in fiscal Q4 2023 (at the end of the previous fiscal year, not to be confused with calendar year), Snowflake's customer adoption stood at 79% y/y growth rates. And now?

Its latest quarter reported 52% y/y growth rates. Indeed, this is something that many bears have remarked. The pace at which the customers' growth rates are decelerating leaves Snowflake with only one tool in its arsenal and that is to consistently upsell to its existing customer base .

And that's undoubtedly challenging as it requires increased wallet share from those customers. Customers who themselves need to be inevitability and overtly "sold to" every quarter, as the majority, if not all, of these customers, are Fortune 500 companies, intent on keeping a lid on their own cost structure.

Revenue Growth Rates Stabilize

After more than 10 quarters of decelerating revenue growth rates, fiscal Q4 2024 points towards roughly similar growth rates as fiscal Q3 2024.

At some point, it was inevitable that Snowflake's revenue growth rates would stabilize. And it appears that its outlook for fiscal Q4 2024 marks this occasion.

Naturally, we are in a position to form an opinion on what fiscal 2025 (calendar 2024) will look like for Snowflake. On this refrain, I have a mixed view. One part of my thesis notes the following aspects.

Here's the inconvenient truth. The size of Snowflake's revenue consensus beats has become progressively smaller. At one point these beats were in the high single digits, while more recent quarters have become small single digits. Truly the smallest acceptable beats for a "high growth tech" company.

However, another part of me declares the obvious insight that Snowflake's comparables have finally started to ease up. This means that it won't be overly difficult for Snowflake to start delivering +30% CAGR next fiscal year.

Consequently, this brings two elements to the foreground. Firstly, a company that is stable and predictable and able to grow at +30% CAGR can be rewarded with a higher premium. Secondly, a company that can deliver a consistent 30% CAGR can put forth a much stronger narrative than a company that has to deal with numerous back-to-back quarters of decelerating revenue growth rates.

To be clear, as the graphic above shows, my observations and growth thesis about fiscal 2025 (calendar 2024) aren't significantly at odds with what analysts presently expect. Accordingly, as you can see above, the Street also expects to see about 30% CAGR for Snowflake in fiscal 2025.

My point is thus, a company that can consistently deliver a solid 30% CAGR will be rewarded with a higher premium, than a company that regularly delivers decelerating revenue growth rates. And that this will impact its forward valuation.

SNOW Stock Valuation -- Rich Premium Already

Snowflake has never been cheaply priced. In fact, there was a period, not long ago, when Snowflake was being priced at +90x forward sales. Looking back to that period today, the present 22x forward sales look pedestrian in comparison.

Moreover, according to some sources, Snowflake is the most expensive stock amongst its brethren.

Can the argument therefore be put forth that Snowflake is still undervalued? On the surface, logic declares this not to be the case. Paying more than 20x forward sales for any company is undoubtedly a stretched multiple. Investors are pricing in a very rosy scenario and then some.

On the other hand, my argument is this, as you know, that its forward prospects over the next 12 months will be more enticing than they have been in recent times.

If investors don't have to go against a compressing multiple, as they have done, and its multiple remains relatively static at about 22x forward sales, together with some top-line growth in fiscal 2025 of around 30% CAGR, this should see its share price move higher over the next twelve months.

Particularly if Snowflake's strong growth rates are able to aid in the delivery of around 10%-12% non-GAAP operating income margin next fiscal year. As a reference point, this fiscal year (the final quarter we are now in) is expected to see around 7% non-GAAP operating income.

The Bottom Line

In conclusion, the outlook for Snowflake has significantly improved, marking a departure from its trend of decelerating revenue growth over the past ten quarters.

The stabilization seen in fiscal Q4 2024, with growth rates similar to Q3 2024, indicates a positive turning point.

Looking ahead to calendar year 2024, there is a compelling thesis that Snowflake can achieve a consistent 30% CAGR or even higher.

The shift from a bearish to a bullish stance is driven by the expectation that Snowflake's narrative will become more attractive, supported by improved fundamentals. While acknowledging some lingering challenges, such as the stretched valuation and the need for consistent upselling to its existing customer base, the overall sentiment is optimistic.

The anticipation of a stable, predictable, and growing company could potentially lead to a higher premium and positively impact Snowflake's valuation over the next twelve months.

Investors will find Snowflake more appealing as it moves towards a period of stronger growth and a potential increase in non-GAAP operating income margin.

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