Snowflake - 2023: Finally Some Margin Progress?

In December, I offered some thoughts into the holiday season for shares of Snowflake (NYSE:SNOW). The company has seen slower growth, yet the business was still growing at an acceptable pace. This was accompanied by still substantial GAAP operating losses, although they were stabilizing in dollar terms, marking some modest operating leverage.

Huge Potential

The potential or hype around Snowflake is that it essentially provides artificial intelligence solutions by reimagining data management for cloud solutions; that was even before ChatGPT was even a term.

The promise is that data should be seamlessly accessible, organized and shared, to unlock the real value of data. Offering a WaaS subscription model, the company was set to benefit from actual consumption of the service, rather than simply moving to a subscription model with fixed monthly revenues tied to it.

The company went public in a very prominent IPO in 2020 as shares were priced at $120 per share, some 50% above the preliminary offering price, as shares hit the $300 mark on that same day, and even the $400 mark later that year and in 2021.

The company has seen a breathtaking pace of growth since the offering. Ahead of the IPO, the company posted $265 million in sales in 2019 on which it posted a huge operating loss of $358 million. The company saw rapid growth in 2020, as fiscal 2022 results (coinciding with the calendar year 2021) rose to a run rate of $1.5 billion based on the fourth quarter results, even before the huge increase in remaining performance obligations.

In the calendar year 2022 (which is actually fiscal 2023 for Snowflake) the company saw rapid growth with first quarter sales up 85% to $422 million, as operating losses came in at $189 million. Second quarter product sales rose 83% to $466 million, with GAAP operating losses increasing to $207 million.

Third quarter product revenues rose 67% to $523 million, with total revenues posted at $557 million, as the company posted a GAAP loss of $206 million. The company did post non-GAAP profits of $43 million, yet stock-based compensation was nearly all but responsible for the discrepancy between both earnings metrics. Despite this observation, GAAP operating losses were flat in dollar terms, showing continued operating leverage amidst topline sales growth.

The company guided for fourth quarter product revenues between $535 and $540 million, trending at $2.2 billion a year. The remaining performance obligation rose by $1.2 billion on an annual basis, for a realistic revenue number around $3.4 billion according to my math.

With 320 million shares granting the business a $48 billion equity valuation at $150 in December, and a $43 billion enterprise valuation given the huge cash position, the business was valued around 12 times sales. Of course, the company was still posting large realistic losses, but the growth and the size of the business were strong achievements in a toughening macroeconomic environment.

Steady

Other than a bolt-on deal at the start of the year, little news was seen on the corporate front, with the exception to the release of the fourth quarter results on the first day of March. Fourth quarter product revenues rose 54% to $555 million, with revenues reported at $589 million. Disappointing is that GAAP operating losses increased to $240 million, although the increase in net losses was mitigated by interest income now being received on cash holdings.

For the fiscal year 2024, the company guided for a solid 40% increase in full year product sales to about $2.70 billion with adjusted operating profits seen around 6%. This compares to 6% adjusted margins in the fourth quarter of 2022 and 5% for the year, as the huge gap with GAAP losses is entirely due to increasing stock-based compensation expenses.

Shares have seen quite some volatility since December, having traded in a $120-$180 range since my update in December, now trading at $150 again. With 322 million shares outstanding, the company still commands a $43 billion enterprise valuation. While the company has seen a reasonably strong fourth quarter in terms of growth, margins remain problematic, as GAAP operating losses actually increased.

And Now

The reality is that with revenues tied to consumption of the services, Snowflake could be hit harder than subscription based-services in a slower economic environment. Amidst this observation, the 40% revenue growth guidance for 2023 (or fiscal 2024) looked a bit underwhelming, but in all honesty still looks pretty decent, as the company has a habit of guiding conservatively.

I am more concerned about the lack of progress on adjusted operating profits, with a huge gap being the result of structural and very real stock-based compensation expenses.

In a market which is not really forgiving for high-valuation technology names, as interest rates creep higher, it is noteworthy that the technology sector at large has done quite alright so far in 2023. The issue is that the business still trades at nosebleed valuations, mostly because growth is decelerating, as the lack of realistic margin pressure is a concern as well.

Hence, I see no reason to alter a neutral stance, albeit that continued growth and a setback in the share price might drive appeal if operational progress is made and shares grind lower.

If you like to see more ideas, please subscribe to the premium service "Value in Corporate Events" here and try the free trial. In this service we cover major earnings events, M&A, IPOs and other significant corporate events with actionable ideas. Furthermore, we provide coverage of situations and names on request!