Snowflake (SNOW 3.69%) is a young cloud computing company benefiting from the emergence of artificial intelligence (AI) as businesses look to expand in that realm. Yet despite what should be some positive catalysts for the company this year, investors aren't feeling all that excited about Snowflake. Year to date, the stock has gained less than 4% even as the S&P 500 has increased 15%, and other tech stocks have been soaring much higher.
There are signs of weakness in Snowflake's business, and investors are concerned that things could get worse.
Snowflake's growth rate is declining
The data cloud specialist reported earnings last week for its second quarter of fiscal 2024 (which ended on July 31). It was a good showing for the company. Revenue of $674 million was up 36% year over year. Snowflake's net revenue retention rate was 142%, which tells us that existing customers are spending more money with the business than they were a year ago -- always a positive sign.
Snowflake sees AI as a promising growth opportunity, with CEO Frank Slootman stating that "enterprises and institutions alike are increasingly aware they cannot have an AI strategy without a data strategy."
But what's disappointing for investors is that while the business is growing by double digits, it's at a lower rate compared to previous periods. In short, it doesn't appear as though AI is giving Snowflake a big boost.
SNOW Revenue (Quarterly YoY Growth) data by YCharts
Its largest customers are its headwinds
One of the surprising comments on Snowflake's recent earnings call was management's reference to its largest customers as a "growth headwind," stating that they "are trying to consume at their contract rate rather than going above that." Large companies are focusing on cutting back on expenses nowadays because many tech outfits expanded too aggressively over the past few years, and that may be why Snowflake's business isn't doing even better than it is.
But the strength in its operations is that it has a wide customer base. Last quarter, Snowflake had 8,537 total customers, up nearly 5% from 8,167 in the previous period. And there were 402 customers with at least $1 million in product revenue over the past 12 months, up from 373 in the first quarter.
The diversity in its customers makes Snowflake a relatively resilient business to invest in. But it's the large customers that should be driving the growth. And if that's a headwind for Snowflake, then it could mean even more deceleration in the growth rate in future quarters, even if the company acquires more customers.
Is Snowflake's valuation too expensive?
Snowflake's business isn't profitable and that can make it difficult for investors to justify paying a big premium for the company. Not only is the growth rate slowing down, but the bottom line doesn't appear to be improving. Last quarter, the company's net loss totaled $226.9 million, which was slightly higher than the $222.8 million loss it incurred in the prior-year period. And through the first two quarters of this year, Snowflake's cumulative net loss sits at $452.5 million, which is 16% higher than the $388.6 million loss it incurred a year earlier.
The stock is trading at 20 times trailing revenue and 9 times book value. Other comparable tech companies with cloud-based platforms include Datadog and CrowdStrike Holdings, which trade at 15 times sales. Snowflake, even though it hasn't surged in value this year, still looks expensive. And if its growth rate slows down, the valuation could look even worse.
Despite the high valuation, the stock does have a consensus analyst price target of more than $190, implying upside of 27% from where it trades today. But if the company's growth rate does continue to decline in future periods, there could be downgrades coming for the stock.
Hold off on buying Snowflake's stock
Snowflake has a promising business that attracts many customers, and many of them spend much more as they stay on with the company. But its operations aren't profitable, and investors are paying a big premium for a business that appears to be slowing down. Top customers should be anchors and growth catalysts for a business, not impediments.
There isn't an overwhelming reason to invest in Snowflake's stock right now. It's best to keep it on your watch list currently rather than in your portfolio.
