SNOW - Snowflake: This Leading Data/AI Platform Is The Cheapest It's Been

2023-11-06 08:00:00 ET

Summary

• Snowflake fits into the “AI theme” by enabling its enterprise customers to make use of their proprietary data.
• Snowflake Cortex allows non-tech users to tap into the potential of generative AI.
• The Total Addressable Market for AI could grow to as large as $1.3 trillion over the next 10 years - a CAGR of 42%.
• Despite being “expensive” relative to other tech stocks, Snowflake is the cheapest it has been.

Snowflake's (SNOW) stock has fallen like a rock from a price close to $400 in the bull market of 2021 / 2022 to a somewhat more reasonable valuation. I believe that the stock has started from what can be considered a bottom at the price of $110 -$140. Given the long-term outlook of the company, this article discusses why now could be a good entry point for SNOW stock.

Snowflake as a Play on AI

Snowflake remains one of the best big data and AI plays in the market. A simplified description of the company is that it is a data cloud vendor that brings together various data from different, and often siloed, systems into a single platform. Within the platform users can query and analyze the data as well as perform complex analysis.

A simple example is that a company could have Salesforce ( CRM ) as its customer relationship management tool, NetSuite ( ORCL ) as its finance tool, and Zendesk ( ZEN ) as its Support management platform. Although each system has its own native reporting, they don't necessarily interact with each other making cross-department reporting and analysis difficult. It is these barriers that Snowflake aims to break.

The big story in recent weeks is generative AI / Machine Learning and the improvements it could make to knowledge work and worker productivity. According to data from ARK Invest , AI tools such as ChatGPT can increase worker productivity by more than 100%.

As you may know, the effectiveness of AI /ML models is primarily driven by their data sets. Having good data is key to "training" these models in order to properly do its tasks. According to ARK Invest, these proprietary data sets could become key competitive advantages for companies. After all, proprietary data almost creates a virtuous cycle as it leads to better AI models, better products and services, more customers, and ultimately more proprietary data. Snowflake fits into the "AI theme" by granting these capabilities to its customers.

Snowflake Cortex Brings the AI Promise to Reality

Given that all of the company's data can be queried on the Snowflake platform, the next logical step would be to apply AI tools to this big data. It is for this reason the company developed Snowflake Cortex - a new service that enables even non-tech users to quickly analyze data and build AI applications. The Snowflake Cortex allows users of all skill sets to use industry-leading AI models, LLMs, and vector search functionality thus tapping into the potential of generative AI.

The tools available in Snowflake Cortex include;

• Large Language Models-based models assist with unstructured data such as Answer Extraction, Sentiment Detection, Translation and Text Summarization
• Machine Learning models that analyze data to perform tasks like Forecasting and Anomaly Detection
• Other general use case AI tools such as Text Completion and Text to SQL

The most interesting feature though of Snowflake Cortex is its "Universal Search" function. Using this feature, customers can easily find tables, views, databases, schemas, and other information within the data lake. Anyone who has worked at a major corporation can tell you that finding the proper data is a major pain point. This tool can answer business questions easily using a ChatGPT-style bot. Snowflake built this feature on technology from Neeva - an AI search start-up acquired by the company last May.

I believe these new products bring tremendous value to the company's enterprise customers and this is just the tip of the iceberg. Snowflake has a whole suite of partnerships and products in the pipeline. This explains why the company has such high customer satisfaction metrics. Snowflakes has a particularly high net revenue retention rate of 142% indicating that over time customers are buying more and more of the company's services.

According to its Q2 fiscal 2024 quarterly press release, the company has 402 customers with trailing 12-month product revenue greater than $1 million. This customer cohort grew 62% year-over-year. The company also has 639 customers out of the Forbes Global 2000 indicating sufficient room to grow. Overall revenues for Q2 2024 experienced a 36% year-over-year growth, from $497.2 million to $674 million. Growth slowed from Q2 last year which was 83% year-over-year. However, it should be noted that the company is achieving solid growth numbers in the context of a tough macroeconomic environment.

Opportunity and Valuation

Snowflake is reporting its fiscal Q3 2024 earnings at the end of November. With the Fed recently pausing interest rate hikes, the market overall is having a second look at beaten-down growth stocks. The company has guided Revenues at the range of $670 - $675 million which represents a 28 -29% growth rate.

Over the long term, the company is poised to ride massive long-term trends. Generative AI and other tools are forecasted to be a massive market. According to research by Bloomberg Intelligence the TAM for AI could grow to as large as $1.3 trillion over the next 10 years. This represents a CAGR of 42%.

The main knock against Snowflake has always been its valuation. Looking at Seeking Alpha's Valuation Quant grade, Snowflake has a valuation of D-. This isn't really surprising as the company isn't really "profitable" despite generating decent cash flow. On a Price to Non-GAAP earnings and Price to Cashflow basis, SNOW stock is trading at 230.2 times and 69.29 times. This is far more than the sector median of 18.33x and 17.5x.

Despite being "expensive" relative to other stocks in this sector, Snowflake is the cheapest it has been. The 18-19x Price-to-sales ratio is much lower than the above 50x it's been trading in 2021 - 2022. The fact of the matter is, Snowflake is an outstanding company that will always be trading at a premium. The same Quant ratings give Snowflake an A+ in its growth grade with forward Revenue growth of 43.5% and forward free cash flow per share growth of 128%.

It's entirely reasonable to wait until SNOW stock's price falls further. However, a fall to "cheap" valuations may never happen. Companies that are world-class typically grow into their valuations and remain expensive for long stretches of time. Think of Amazon ( AMZN ) or Tesla ( TSLA ) and many more examples. So unless you are Warren Buffett you may never get a better deal on SNOW stock than what you see today.

Key Risks And Conclusion

Note: While I have been highly optimistic about SNOW stock for this article, I do have to point out a few key risks to my bullish thesis. First is that Snowflake is trading at expensive valuations of 18-19x Price-to-sales ratio. This has been a year where growth stocks have been decimated for missing earnings. Expect a drop in SNOW stock should earnings disappoint at the end of the month.

Furthermore, there is always the risk of the US falling into a "hard-landing" type recession. This may cause Snowflake's enterprise clients to cut down on spending as they attempt to conserve their budgets. Growth stocks like SNOW will decline much more than the broader index in this scenario.

Finally, in the long term, Snowflake faces a few competitive threats. Privately-owned Databricks is gaining momentum . The company also has a weird "frenemy" type relationship with major cloud vendors Amazon and Google (GOOG). These cloud vendors could vertically integrate and start offering their own in-house service to displace Snowflake. This is why it is so important that Snowflake stays ahead of the curve when it comes to technology and why I have discussed at length what it is doing to adapt to the new AI/ML world.

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