Snowflake (NYSE:SNOW) is a leading data warehouse provider, which is rated with 4.5 stars out of 5, according to G2 Reviews. This is higher than AWS Redshift which has just 4.3 stars out of 5. Snowflake’s platform breaks down “data silos” across organizations and multiple clouds, which enables insights to be unlocked through advanced analytics and AI. Therefore, it should be no surprise that Snowflake is poised to benefit from the growth in multiple industries including the Hybrid cloud, AI and of course “Big Data”. The Big Data industry alone is forecast to grow at an 11% compounded annual growth rate [CAGR] and reach a value of over $273 billion by 2026. In the fourth quarter of FY23, the company reported solid financial results as it beat revenue growth forecasts. However, due to slowing growth rates and tepid guidance, SNOW stock price fell by ~7% in after-market trading. This compounds on top of Snowflake’s share price decline of over 60% since November 2021. I personally believe this is a market overreaction due to the aforementioned industry tailwinds, its high customer retention, and its large amount of contracted revenue. In this post, I’m going to break down the company’s fourth quarter financials, before revealing my valuation model and forecasts for the stock. Let’s dive in.
Solid Fourth Quarter Financials
Snowflake reported solid financial results for the fourth quarter of fiscal year 2023. Its revenue was $589 million, which increased by a rapid 53% year over year and beat analyst estimates of ~$576 million (Google Finance data). I always like to compare historic growth rates to get an overall gauge of a company’s progress. In this case, Snowflake’s Q4 growth rate is slightly slower than Q3 FY23 which was 66.55% and slower than Q2 FY23 which was 82.68% year over year. The good news is this is a common trend I have seen across almost every technology company I have analysed over the past year (see my other post). It should be noted that the vast majority (94%) of Snowflake’s revenue was from its product, which charges based on platform “consumption” (partially) with “rollover” of usage permitted. This basically means if its customers’ business demand slows down, there may be less of a need to consume storage and do data transfer processes, thus lower revenue is expected. In its earnings call, management also reported lower demand from its international SMB customers, which are more vulnerable to macroeconomic effects than its larger customers. The good news for Snowflake is its growth rate is still one of the fastest rates I’ve seen (in my coverage of technology companies, see my other posts), given the backdrop.
I believe customer retention is more important than growth, because if you can’t keep your customers, the whole customer acquisition process becomes an expensive treadmill. Luckily for Snowflake, it has a super high net retention rate of 158%, which means customers are staying with the platform and spending more through upsells/cross-sells etc.
Its remaining performance obligation [RPO] was $3.661 billion in Q4 FY23, which increased by ~38% year over year. The RPO metric is the amount of contracted future revenue, and thus this offers investors some certainty with regards to revenue. In fact, 55% or ~$2 billion of its RPO for Q4 FY23 is expected to be recognized as revenue over the next 12 months of the calendar year 2023 (fiscal year 2024). This metric is surprisingly up from the 52% reported in Q4 FY22.
Its total customers were 7,828 in Q4 FY23, which increased by a solid 31% year over year. Sequentially, between Q3 FY23 and Q4 FY23, its customer growth increased by 6.8%. This is slightly slower than the 7.6% sequential growth between Q1 FY23 and Q2 FY23, but not majorly so.
The word “innovation” gets thrown around a lot these days but Snowflake really does embody this. The company has over 60 patents across many areas from multi-cloud “clean rooms” to specialised views of a database system. I believe these multitude of patents could act as a competitive advantage, especially against new startups, which will be unlikely to have the firepower to compete in a patent court battle.
In the fourth quarter of FY23, Snowflake made its “Snowpark for Python” product generally available. This basically offers a “better, faster, cheaper” way for data scientists to “Spark jobs”. Without getting into too many technical details, we do know ~20% of its customers have now tried Snowpark, which is a positive sign.
Its initial PoC or Proof of Concept activity has also been solid with a financial services customer, gaining an 8 times faster process at 30% of the cost. In terms of actual revenue from this new product, CEO Frank Slootman estimated on the earnings call that by the second half of 2023 (calendar year), revenue will start to trickle in and then scale from there.
Snowflake is also “replatforming” Streamlit (a popular development environment used to create web/data apps). This platform has become immensely popular especially given the rise of Artificial Intelligence [AI].
The AI industry was valued at $136.55 billion in 2022 and is forecast to grow at a rapid 37.3% CAGR, up until 2030. I forecast Snowflake to benefit from this trend.
Margins and Balance Sheet
Moving onto profitability, the company reported an operating loss of negative $239.75 million, which was greater than the negative $152 million reported in Q4 ’21.
A positive is if I compare expenses as a portion of revenue, over the past few years, the trend is positive. For instance, in FY21, Sales & Marketing expenses (blue box on chart below) made up 63% of revenue. By FY22, this figure had dropped to just 43% of revenue and by FY23 this figure had dropped to just 39% of revenue. This is a positive sign as it effectively means the company is growing its customer base (and revenue) at a much faster rate than its expenses. The same trend is true for R&D investments which has dropped from 17% of the total in FY21 to just 9% of the total by FY23. It was also great to see general and administrative expenses slowing down considerably from making up 17% of revenue in FY21 to just 9% by FY23.
Snowflake’s balance sheet is also robust with ~$4 billion in cash, cash equivalents and short-term investments. In addition, the company has virtually zero debt with ~$224 million operating lease liabilities, but this is not interest bearing and thus technically not debt.
Valuation and Forecasts
In order to value Snowflake, I have plugged its latest financial data into my discounted cash flow valuation model. I have forecast 40% revenue for “next year” or the next four quarters in my valuation model. This is based upon management’s guidance of $2.75 billion in product revenue for FY24. Given product revenue contributes to ~94% of the total, I have kept the growth figure level for total revenue. I forecast this to be driven by ongoing customer contracts as well as industry growth across the growth in the hybrid cloud, big data and even AI. This growth rate is also aligned with the slowing growth rate trend over the past few quarters with 53% YoY revenue growth reported for Q4 FY23. In years 2 to 5, I have forecast a faster revenue growth rate than year one of 45% per year. I forecast this to be driven by improving economic conditions, which should help to cause a surge in consumption based revenue. In addition, I believe Snowflake’s new products such as its “Snowpark for Python” will start to generate significant revenue by that period. Management has also forecast a substantial $10 billion in product revenue by the fiscal year 2029, and thus this forecast aligns with that.
To increase the accuracy of my model, I have capitalized R&D expenses which has boosted net income. I have forecast its operating margin to increase to 25% over the next 10 years. Management has forecast a non-GAAP operating profit margin of 6% by FY24 and thus I have extrapolated this out to slightly higher than the 23% average margin in the software industry (NYU data). I am also referring to GAAP profitability, which is forecast to be driven by improving operating leverage as per the current trend.
Given these factors, I get a fair value of $153 per share, at the time of writing, the stock is trading at ~$143 per share (including the pre-market sell-off), and thus I deem the stock to be 6.72% undervalued intrinsically.
Snowflake also trades at a price to sales ratio = 16.5, which is over 50% cheaper than its 5-year average. Comparing Snowflake to competitors is challenging as it offers a similar service to Amazon’s (AMZN) RedShift data warehouse but of course, Amazon’s ecommerce business skews its P/S ratio = 1.69. I have added a few other database providers and technology companies below for completeness.
Many analysts have forecast a recession for 2023, therefore as Snowflake derives part of its revenue from “consumption” based pricing, a slowdown in revenue growth is expected. The positive is its retention rate is super high (158% in Q4 FY23) and thus I don’t believe the company will lose customers over a recession. In fact, during uncertain times, large organizations may wish for more analytics and AI forecasts to help gauge the foggy environment.
Snowflake is a tremendous technology company which is truly a leader in the data warehousing industry. The company has continued to execute on its growth exceptionally well and has super high retention rates, with a large pipeline of bookings. Overall, this should help the company to ride any “storm”, especially as large organizations tend to plan multi-year timelines for digital transformation projects. Its stock has historically been known as “overvalued”, but now it looks as though the gap between price and value has closed somewhat, and thus the stock could be a great long-term investment.