SNOW - Snowflake: Temporary Melting Downgrade To Hold

2023-08-29 16:19:18 ET

Summary

• We’re downgrading Snowflake Inc. to a hold.
• While we still expect sequential and Y/Y revenue growth, we think growth could moderate more through 2H FY2024 due to the industry-wide cost optimization effort.
• We now believe our investment thesis of SNOW monetizing the gen A.I. opportunity with Nvidia Corporation and Microsoft Corporation may take longer to play out.
• We think FY25's expectation could be too aggressive.
• Despite the recent pull of the stock price, we think the risk-reward remains favorable and recommend investors stay at the sideline for now.

We're downgrading Snowflake Inc. ( SNOW ) to a hold. While we continue to expect sequential and Y/Y revenue growth into 2024, we think growth will likely moderate through the second half of FY24 due to the industry-wide cost optimization effort. We think customers will be more disciplined in spending and consumption due to the uncertain macroenvironment in 2H23.

We now think our investment thesis regarding SNOW monetizing the generative A.I. opportunity after June announcements of new and extended partnerships with Nvidia ( NVDA ) and Microsoft ( MSFT ) to take longer to play out. The stock rallied in June and July on high investor confidence in the company's data strategy to leverage gen A.I. through its Snowflake Data Cloud; the stock run-up was largely triggered by the Snowflake Summit held in late June. The stock price has pulled back significantly since, down 16% in the past month, underperforming the S&P 500 (SP500) by around 13%. We think the pullback somewhat prices in near-term headwinds and continue to see a favorable risk-reward profile for the stock. Our downgrade is driven by our belief that SNOW is facing high expectations that the business won't be able to meet due to the cost-optimization environment impacting customer consumption. We also think FY25's expectation could be too aggressive as we see macro headwinds potentially spilling into early next year.

The following graph outlines SNOW's YTD performance against the S&P 500.

We're constructive on SNOW's relative resilience to the uncertain macro environment; 2Q24 results reflect continued solid growth, with revenue up 35.5% Y/Y and 7.5% QoQ to $674M and product revenue up 37% Y/Y to $640.2M. We expect the company to continue reporting double-digit revenue growth Y/Y in 2H23 but believe growth could moderate due to the cost-cutting environment and softer customer consumption.

Highlighting this is SNOW's slower revenue growth percentage Y/Y over the past four quarters; last quarter, revenue grew 47.6% Y/Y, 53.5% Y/Y in 4Q23 and 66.7% Y/Y in 3Q23. We think SNOW's revenue growth will remain solid in 2H23, reflecting stabilization but not recovery or A.I. demand tailwinds. Management guided for product revenue of $670-675M, accounting for an increase of 28-29% Y/Y and 4.5-5.2% QoQ. Product revenue guidance continues to be in the same range as the past four quarters despite the gen A.I. hype in the Summit and on the earnings call this quarter. The guidance confirms our expectation that the gen A.I. opportunity will take longer-than-expected to play out.

Valuation

The stock is not cheap, trading well above the peer group average. The stock is trading at 13.0x EV/C2024 Sales versus the peer group average of 7.9x. While we like SNOW's position to monetize gen A.I. in 2024, we don't see the stock meaningfully outperforming in the near-term and don't see attractive entry points at current levels.

The following chart outlines SNOW's valuation against the peer group.

Word on Wall Street

Wall Street is bullish on the stock. Of the 45 analysts covering the stock, 28 are buy-rated, 16 are hold-rated, and the remaining are sell-rated. We think Wall Street is chasing the A.I. hype and hence sees potential growth exposure for SNOW.

The stock is currently priced at $151 per share. The median sell-side price target is $195, while the mean is $199, with a potential 29-32% upside.

The following charts outline SNOW's sell-side ratings and price-targets.

What to do with the stock

We're downgrading SNOW to a hold. We upgraded the stock to a buy in mid-July on expectations of a potential A.I. growth opportunity in 2H23, but we now see this thesis taking longer to play out. We see growth moderating in the second half of FY24 due to the uncertain macro environment and believe SNOW's current premium valuations are not justified for near-term cost-optimization headwinds. Despite the recent pull of Snowflake Inc. stock price, we think the risk-reward remains favorable but recommend investors stay at the sideline for now.

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