Snowflake: Dead Money Walking For Now

Snowflake Inc. (NYSE:SNOW) disappointed investors yesterday (May 24) as it reduced its revenue outlook and lowered its profitability projections, given uncertain macroeconomic uncertainties.

As such, SNOW is down more than 12% in post-market at writing, as investors assessed the time taken for such uncertainties to abate. Management was reticent in providing more clarity over the expected growth inflection, even though the company remains confident in its long-term game plan.

Hence, Snowflake didn't adjust its long-term outlook of $10B in product revenue by FY29 with a "better margin profile." However, given SNOW's expensive valuation, the challenge for holders is how to navigate the near-term challenges in its sales cycle if the optimization trends continue.

Management pointed out to investors that Snowflake is more exposed to the growth drivers underpinning Amazon Web Services or AWS (AMZN). CEO Frank Slootman articulated that "Amazon is such a large percentage of [Snowflake's] overall deployments that they are a good proxy. So there's definitely a ripple effect because [Snowflake's] in the stack."

Keen investors should recall that AWS reported a significant slowdown recently, as "AWS notched only a 16% YoY rise in its topline for FQ1, hampered by ongoing optimization and macro challenges."

However, Snowflake's cloud-agnostic model suggests that it should be exposed to multi-cloud deployments, helping mitigate the revenue growth slowdown. Despite that, a general downturn in the hyperscaler space was noted in Q1, affecting Snowflake's revenue growth, given its usage-based consumption model.

Moreover, while Microsoft (MSFT) notched robust growth last quarter, Slootman reminded investors that its "Microsoft [exposure] is smaller, so they're not as predictive of [Snowflake's] experience as AWS would be."

With that in mind, I expect the overstated consensus estimates to be revised downward, given SNOW's remarkable recovery from its early 2023 lows. I updated investors in my previous article that SNOW's pullback should be bought, as it significantly outperformed the S&P 500 (SPX) (SPY).

Accordingly, Snowflake communicated guidance of $2.6B in product revenue for FY24 (up 34% YoY), predicated against a reduced adjusted operating margin of 5%. Although it's just 1% point lower than Wall Street estimates, the magnitude of the reduction, given its relatively weak adjusted profitability, suggests that we must be more cautious now.

Notwithstanding, Snowflake stressed that it remains well-primed to leverage AI workloads, given its ability to leverage data sharing and storage, as it "manages a vast and growing universe of public and proprietary data." Therefore, the company believes its services remain highly relevant and in demand. The company also highlighted that its "customer base for data science, machine learning, and AI workloads grew by 91% year-over-year."

However, it must first navigate near-term macro and enterprise spending challenges, although the company expects the "trend to reverse." In addition, management stressed that the falling net revenue retention rate of 151% is being hampered by older cohorts, as "newer cohorts are growing faster."

As such, the company is confident that "there is plenty of demand" driven by AI workloads. Hence, investors are urged to remain patient as the company navigates short-term macro headwinds.

However, I understand why the market has little patience for a tepid outlook. SNOW's "F" valuation grade indicates that it's priced for perfection, with little margin for error or disappointment.

Given management's less optimistic near-term guidance, investors must account for increased execution risks, as the recent recovery has likely reflected significant optimism.

With the post-market pullback, SNOW is less overvalued but nowhere attractive to consider adding. Its price action is also not constructive, and thus I don't see a particularly enticing entry point, even for a speculative entry.

As such, I move to the sidelines from here.

Rating: Hold (Revised from Buy).

Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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