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Until tech stocks came back down to earth this year, Snowflake (NYSE:SNOW) had been one of the hottest trades on Wall Street since the pandemic began. This cloud data warehousing company was a hot commodity since its IPO in 2020 at $120 per share, earning its stripes for being one of the few tech companies to merit an investment from Warren Buffett (who famously doesn’t like to invest in companies he doesn’t personally understand – and Snowflake’s complex infrastructure software is certainly out of reach for most non-technical investors).
Snowflake dazzled Wall Street for its humongous growth rates, having doubled its revenue on a y/y basis every quarter since it went public. Its use cases are endless (what company doesn’t have a need for data?) and its relatively lower penetration and lack of major name-brand competitors allowed it to grow incredibly fast. Yet of course, the narrative turned on its head this year as tech stocks collapsed. Year to date, shares of Snowflake have lost more than 50% of their value; and in fact, the company has given up almost all of its gains since its IPO two years back, which I think to be an important trigger for us to reassess the bull case for this stock. Relative to all-time highs above $400 notched last November, Snowflake has shed 60% of its value.
I last wrote on Snowflake in November when it was trading in the ~$370 range. I had cautioned investors then to wait for the impending dip, as Snowflake’s valuation and reached frightening levels. Now, amid still-strong growth and a much-reduced share price, I am finally changing my tune on Snowflake and recommending a buy here. Don’t bet the farm on Snowflake – I expect we’ll still see quite a bit of volatility here as the market continues to digest inflation data and de-risk out of growth stocks, but if your time horizon is longer than a year, I think now is an excellent entry point for Snowflake.
The bull case for Snowflake
An important question for investors who are newer to Snowflake: what does this company do, exactly?
From Snowflake’s own words describing its products in the S-1 filing:
Our platform solves the decades-old problem of data silos and data governance. Leveraging the elasticity and performance of the public cloud, our platform enables customers to unify and query data to support a wide variety of use cases. It also provides frictionless and governed data access so users can securely share data inside and outside of their organizations, generally without copying or moving the underlying data. As a result, customers can blend existing data with new data for broader context, augment data science efforts, or create new monetization streams. Delivered as a service, our platform requires near-zero maintenance, enabling customers to focus on deriving value from their data rather than managing infrastructure.”
Its technology essentially acts as a “system of record” for a company’s data stack, allowing IT to build and deploy applications from that database. Platforms like Snowflake have become far more relevant in the modern cloud computing era because nowadays, a large amount of corporate data resides in the cloud, and within different applications. Companies, for example, lean on HR data residing in their Workday cloud (WDAY), or on sales/customer data contained within Salesforce’s Sales Cloud. These are relatively new problems, because in the “old” computing era, companies’ applications were installed on-premise and not within a myriad of other applications. A unifying “data cloud” like Snowflake helps to break down these siloed data locations to provide a “single source of truth” and drive better business insights.
To me, here are the key reasons to be bullish on Snowflake:
- Humongous growth rates. If you needed proof that Snowflake’s market is a massive one, you only need to look at the company’s top-line growth rate. Even at a ~$2 billion annual revenue scale, the company is still managing to grow at a ~2x y/y pace. That signifies that Snowflake is nowhere near the saturation point, and that there are still plenty of customers left to go – large and small.
- Large TAM. More to the point above, Snowflake estimates its overall cloud data platform TAM at $90 billion, suggesting that at its current scale, Snowflake is only single-digit percentage penetrated into this market.
- Consumption-based revenue model. Snowflake adamantly declares that it is not a SaaS company. It charges its customers based on data usage, and this means that as data volumes grow, Snowflake grows as well. Snowflake boasts net revenue retention rates above 170%, which is an insanely high number far above most other software companies (which tend to be in the ~110-120% range). Snowflake grows not only by adding new customers, but by expanding significantly within the existing customer base.
- Profitable bones. Snowflake’s ~70% pro forma gross margins have allowed the company to significantly scale up its profitability as it grows substantially larger. In FY22, the company achieved a -3% pro forma operating margin, which is almost unheard of for a company still growing at a >2x y/y pace. Forget the “Rule of 40” – Snowflake is closer to a “Rule of 100”, and is in a class of its own.
Of course, Snowflake isn’t cheap – even after the recent crush in its share price. But the good news is, it’s cheaper now than it ever has been. At current share prices near $158, Snowflake trades at a market cap of $49.82 billion. After we net off the substantial $5.11 billion cash pile on the company’s most recent balance sheet, Snowflake’s resulting enterprise value is $44.71 billion.
For the current fiscal year FY23 (the year ending in January 2023) and for the following fiscal year FY24, Wall Street analysts have consensus revenue targets of $2.03 billion (+66% y/y) and $3.14 billion (+55% y/y), respectively. This puts Snowflake’s valuation multiples at:
- 22.0x EV/FY23 revenue
- 14.2x EV/FY24 revenue
Near-term multiples certainly don’t look cheap, but as long as you believe in Snowflake’s growth trajectory, I see a path to the company having a reasonable valuation against FY24/calendar ’23 revenue, especially if the company continues to scale up its bottom-line (the company is projecting to have slightly positive operating income this year alone).
So far, results show nothing but staggering growth
Part of the reason Snowflake shares have fallen this year is that investors were crestfallen with the company guiding to mid-60s growth for FY23 and ~80% y/y growth in Q1, when Snowflake had been consistently showing >100% y/y growth rates over the past several quarters. Yet so far, we’ve seen barely any hint of deceleration at all, and so we should recognize that Snowflake’s actual results have been tremendously robust.
Take a look at the company’s Q4 earnings summary, released in early March, in the table below:
Snowflake’s revenue in Q4 grew at a 102% y/y pace to $383.7 million, handily outpacing Wall Street’s expectations of $372.8 million (+96% y/y) and barely decelerating from Q3’s 104% y/y growth pace.
The company also added 14 net-new Fortune 500 customers in the quarter (+24% y/y growth in the Fortune 500 customer base) and 21 net-new Global 2000 customers. While the consistent customer growth in itself is impressive, I am even more enthused by the fact that there’s still more than half of the Fortune 500 and more than three-quarters of the Global 2000 to sign on.
And, as previously mentioned, Snowflake’s consumption-based business model has also led to staggering revenue retention rates that are the envy of the tech sector. In Q4, net revenue retention rates hit a high of 178%, five points stronger than in Q3:
Here’s some commentary from CEO Frank Slootman’s prepared remarks on the Q4 earnings call, detailing what the company’s go-to-market priorities are for FY23:
Our priority for the year is essentially unchanged and is as follows: first, the enablement and expansion of our workload types. Nothing is more core to our mission to develop the data cloud. The existing workload types, such as data lake, data engineering and data science develop continuously to become more functional, efficient and performance. New workload types will be announced later this year […]
Secondly, we’re expanding our use cases by vertical industry as well as functions such as IT, sales, marketing, finance and engineering. We are continuing to drive collaboration through data sharing with leading enterprise software companies to drive this trend.
Third, as of February 1, we have also verticalized part of our selling motion to address our largest customers by industry.
Lastly, we’ll continue to deepen and broaden our geographical scope, expecting faster growing contributions coming from outside the United States. We’re excited about starting a new Snowflake fiscal year.”
The company also does continue to make consistent margin progress, which is largely expected when pro forma gross margins are sitting in the ~70s and revenue growth is doubling y/y without significant expansions in headcount. In FY22, the company achieved a -3% pro forma operating margin (21 points better than -24% in FY21), driven by a 20-point reduction in sales and marketing expenses as a percentage of revenue, and in FY23, the company expects to hit a 1% operating margin.
Additionally in FY22, Snowflake achieved $149.8 million in adjusted free cash flow at a 12% margin, up 24 points on a margin basis versus -12% in FY21. With these kinds of profit metrics, it’s hard for bearish investors to make the argument that Snowflake is a “growth at all costs” company.
I’ve never argued that Snowflake was lacking fundamentally: it just always has been, and continues to be, quite an expensive stock. Yet I think the ~60% correction from highs alongside continued hyper-growth and margin expansion represents a great entry point for the long-term oriented investor. Now is the time to dip your toes in.