5 Red Flags for Snowflake’s Future





snowflake‘s (SNOW -6.42% stock price sank 22% during after-hours trading on Wednesday, March 2, following the release of its fourth-quarter earnings report.

The cloud-based data warehousing company’s revenue rose 101% year over year to $383.8 million, beating analysts’ estimates by $11 million. Within that total, its product revenue grew 102% to $359.6 million.

Snowflake’s total number of customers rose 44% year over year to 5,944. Its number of customers that generated more than $1 million in trailing 12-month product revenue jumped 139% to 184. It ended the quarter with a net revenue retention rate of 178%, compared to 168% a year ago.

An electrical circuit shaped like a snowflake.

Image source: Getty Images.

Snowflake remained unprofitable, but it narrowed its net loss from $198.9 million to $132.2 million, or $0.43 per share, which also surpassed analysts’ expectations by $0.12. Those headline numbers looked impressive, but five red flags seemed to spark a retreat from the high-growth cloud stock.

1. It’s top-line guidance

For the first quarter, Snowflake expects its product revenue to grow 79%-81% year over year. For fiscal 2023, it expects its product revenue to increase 65%-67%. Analysts expect its total revenue to increase 65% for the year, then grow another 57% in fiscal 2024.

Snowflake’s guidance is impressive, but it would represent a significant slowdown from its 174% growth in fiscal 2020, 124% growth in fiscal 2021, and 106% growth in fiscal 2022.

2. It’s frothy valuation

At $265 per share, Snowflake was valued at $81 billion, or 40 times its projected sales for fiscal 2023. After its 22% post-earnings haircut, the stock still trades at about 30 times this year’s sales. That price-to-sales ratio makes Snowflake more comparable to other “hyper-growth” cloud stocks like cloudflare ( JUST -2.97% and CrowdStrike (CRWD -6.28%

Company

Revenue Growth* (Current FY)

P/S Ratio (Current FY)

snowflake

65%

32

cloudflare

42%

42

CrowdStrike

64%

32

Data source: Yahoo Finance, March 3. Note: Revenue growth is estimated. P/S = Price to Sales.

All three stocks struggled over the past six months as inflation and rising interest rates sparked a rotation away from higher-growth tech stocks.

SNOW Chart

Data source: YCharts

Snowflake still can’t be considered a screaming bargain after its post-earnings plunge, and its premium price-to-sales ratio could prevent new investors from hopping aboard as macro headwinds rattle the market.

3. Peaking gross margins

Snowflake’s adjusted product gross margin expanded from 69% in fiscal 2021 to 74% in 2022, but it only expects a slight expansion to 74.5% in 2023. That’s just 50 basis points below its long-term adjusted gross margin target of 75% for fiscal 2029, which it set during its investor day last June.

Snowflake’s peaking gross margins suggest its pricing power is ultimately limited. That’s troubling, because Amazon (AMZN -1.53%Microsoft (MSFT -2.05%, and other cloud-based software giants have all been gradually strengthening their own data warehousing solutions. Snowflake also runs on top of Amazon Web Services (AWS) and Microsoft Azure, so it’s ironically paying recurring cloud hosting fees to its biggest competitors.

Amazon and Microsoft can both leverage the strength of their cloud platforms to challenge Snowflake with bundles, discounts, and other loss-leading strategies. They can also quietly raise Snowflake’s cloud hosting fees. Those headwinds could all prevent Snowflake from ever achieving a profit.

4. Its ongoing dilution

Snowflake’s total number of weighted-average shares jumped 216% in fiscal 2021, then increased another 112% in fiscal 2022. Its share count is skyrocketing because it’s subsidizing its salaries with big stock bonuses to conserve cash, which caused its stock-based compensation expenses to more than double in 2022 and consume 50% of its revenue.

5. Its overly bullish goals for 2029

Last June, Snowflake told investors that its annual product revenue could grow at a compound annual growth rate (CAGR) of 43.6% between fiscal 2021 and fiscal 2029 to $10 billion by the final year. That would represent a whopping 777% increase from its $1.14 billion in product revenue in fiscal 2022.

Snowflake plans to reach that goal by locking in 1,400 customers with more than $1 million in trailing 12-month revenue, compared to just 184 at the end of fiscal 2022. Those targets are impressive, but they could also be far too bullish. If Snowflake’s growth stalls out and it walks back those estimates at its next investor day this June, its pricey stock could get crushed.

Stick with other cloud stocks for now

Snowflake’s core business remains strong. But its growth is decelerating, it’s drowning in red ink, its valuations are high, and its share count is soaring. Those weaknesses all make it a risky stock to hold in this wobbly market — so investors should stick with more stable cloud-based growth stocks instead.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.




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