Cloud-native data warehousing specialist Snowflake's (SNOW -1.61%) shares fell by over 15% after the company released results for the first quarter of fiscal 2024 (ending April 30). Although the company's revenues and earnings have surpassed consensus estimates, broader economic conditions seem to have put downward pressure on the company's future growth outlook.
Since then, Snowflake's shares have again recovered by over 21% in the past week. Is the recent bull rally sustainable? Let's assess the bullish and bearish case for the stock in greater detail.
The bull case
The increasing adoption of artificial intelligence (AI) and machine learning across industries and functions is undoubtedly a major tailwind for Snowflake. The company's scalable, secure, and cloud-provider agnostic data platform (interoperable with Amazon's AWS, Alphabet's Google Cloud, and Microsoft's Azure) is playing a major role in breaking down silos of structured and unstructured data and analyzing them to help make optimal data-driven decisions.
Further, the launch of ChatGPT has highlighted the importance of generative AI -- a market estimated to grow annually at a compounded average growth rate of 27% to $118 billion by 2032. Generative AI is based on large language models, which use huge amounts of processing power to analyze complex data sets. Since Snowflake's data platform separates data storage and computation resources and allows for easy scalability of any enterprise resource without major downtime or disruptions, it is positioned to benefit from this growing market opportunity.
Snowflake has further strengthened its machine learning and AI capabilities through acquisitions and partnerships. The company acquired the time series forecasting company Myst to extend machine learning capabilities on its data cloud, as well as a suite of tools called SnowConvert from Mobilize Net to enable enterprises to efficiently migrate databases to its data cloud.
Virtualitics, an artificial intelligence and data exploration company, launched an AI platform on Snowflake's data cloud. The company also offers a Snowpark programmability platform, geared at data scientists and engineers, to build customized products.
Thanks to the constant focus on innovation, Snowflake reported an exceptional dollar-based net revenue retention rate of 151% in the first quarter, which means that on average, customers spent 51% more than that spent by the same cohort in the same quarter of the last year. This implies that the company's offerings continue to be preferred by large enterprises.
The bear case
Snowflake reported revenues of $623.6 million in the first quarter, up 48% on a year-over-year basis. While the top-line growth rate is still impressive on an absolute basis, it marks a significant deceleration from the 69% year-over-year revenue growth delivered in fiscal 2023. The slowdown in revenue growth is mainly due to weakening demand trends in the broader cloud services market.
In the current uncertain macroeconomic environment, enterprises have been cutting costs and optimizing cloud spending. The company's remaining performance obligation (RPO, an indicator of future revenue growth potential) grew by 31% year over year to $3.4 billion.
However, RPO was down 7% sequentially. Since Snowflake operates a consumption-based pricing model, enterprises can reduce usage and expose the company to higher revenue volatility in recessionary times.
Snowflake reported an adjusted net profit of $54 million, far better than the $1.5 million net loss in the year-ago quarter. But high stock-based compensation costs resulted in a significant expansion in generally accepted accounting principles (GAAP) losses in the same time frame. Further, investors were also disappointed with weaker-than-expected guidance for the second quarter and reduced revenue outlook for the full fiscal 2024 year (ending Jan. 31, 2024).
Finally, Snowflake is trading at a price-to-sales ratio of 25x. While at near-historic low levels for the company, this valuation is still significantly higher than price-to-sales multiples of other major cloud data providers such as Amazon, Microsoft, and Alphabet, which stand at 5.8x, 12.1x, and 2.4x, respectively. Despite the stock tanking by almost 60% below its all-time high in late 2021, Snowflake's valuation is still on the expensive side -- and it looks unjustified for a company with slowing top-line growth amid several structural headwinds.
So is Snowflake a buy?
It is obvious that Snowflake's exposure to AWS customers has put solid downward pressure on the share price. Further, the soft demand environment and weaker-than-expected near-term outlook are also proving to be a drag on the overall investor sentiment.
Yet the company's long-term growth story is intact, especially since AI is gradually taking over several of our daily activities. Hence, while a further dip in the stock due to the tough macroeconomic environment is still a possibility, Snowflake can prove to be an attractive pick for patient long-term investors. Investors can opt to buy the stock at a range of prices (a dollar-cost averaging strategy), which may further help mitigate risk.
