Snowflake Stock: Price drop opens decent entry point (NYSE: SNOW)

Various photographs/iStock Editorial via Getty Images

Introduction

After reporting another stellar quarter, Snowflake’s (NYSE:SNOW) the stock tumbles amid a tough macro backdrop and management’s expectations for slowing revenue growth. While Snowflake is still one of the most expensive growth stocks (due to its trading multiples), the sharp squeeze in the valuations of this high-quality business could prove to be an excellent entry point for long-term investors. To read our original investment thesis for Snowflake (published at the time of its IPO), please refer to this note:

  • Let it snow, let it snow, let it snow

In today’s note, we’ll walk through Snowflake’s fourth quarter 2021 report and assess the company’s long-term outlook. Additionally, we will consider Snowflake’s valuation to formulate an investment decision.

Dissecting Snowflake’s Q4 Report

In Q4 2021, Snowflake revenue snowballed as more enterprises continued to move their workloads to the cloud. With quarterly revenue growing approximately 101% year-over-year to $384 million, Snowflake easily exceeded consensus analyst expectations and management forecasts.

Snowflake Q4 2021 Results Presentation

Snowflake Q4 2021 Results Presentation

The strength of Snowflake’s revenue growth is twofold –

  1. Expansion within existing customers, and
  2. Acquisition of new customers

While many enterprise SaaS companies have strong net retention rates, I’ve never seen anything quite like Snowflake (178% NRR) before in my investing career. As customers continue to increase their use of Snowflake’s data cloud for storage and compute solutions, Snowflake’s revenue is growing like wildfire.

Snowflake Q4 2021 Results Presentation

Snowflake Q4 2021 Results Presentation

In Q4 2021, Snowflake’s customer count reached 5,944 (up 44% year-on-year), with 184 customers now contributing more than $1 million in annual product revenue. Snowflake is focused on the large enterprise market and its customer base now includes 241 Fortune 500 organizations and 488 Forbes Global 2000 organizations (including overlaps).

Snowflake Q4 2021 Results Presentation

Snowflake Q4 2021 Results Presentation

Snowflake Q4 2021 Results Presentation

Snowflake Q4 2021 Results Presentation

While Snowflake’s revenue base is growing rapidly, this hypergrowth certainly doesn’t come at the expense of margins. Snowflake’s product revenue (93% of total revenue) now generates GAAP gross margins of approximately 70% [non-GAAP: 74%]against 65% [non-GAAP: 69%] from a period of one year ago. A margin expansion with such growth reflects the strong demand for the Snowflake platform in the market.

Snowflake Q4 2021 Results Presentation

Snowflake Q4 2021 Results Presentation

In addition to gross margin improvements, Snowflake’s business model provides significant operating leverage at scale. Now, Snowflake’s GAAP operating expenses are always greater than its revenues; however, the charts below show a very healthy trend for Snowflake’s profitability. As operating expenses as a percentage of revenue decrease, Snowflake becomes FCF positive (at least on a non-GAAP basis, i.e. after removing non-cash SBC expenses, Snowflake is already generating positive free cash flow).

Snowflake Q4 2021 Results Presentation

Snowflake Q4 2021 Results Presentation

As we know, Snowflake’s T1 and T4 will likely be stronger than T2 and T3 due to billing cycles and renewals. Since Snowflake’s business model is consumption-based (not a SaaS model), we’ll likely see more volatility in its free cash flow than we see at other enterprise SaaS companies. Therefore, I don’t see the Q4 FCF numbers as an inflection point.

Snowflake Q4 2021 Results Presentation

Snowflake Q4 2021 Results Presentation

Snowflake is still in the hypergrowth phase and its experienced management team is unlikely to compromise growth for near-term profitability. And so, I don’t expect to see tons of free cash flow or positive earnings from Snowflake anytime soon.

Midway through management’s forecast for 2022, Snowflake’s revenue growth rate is expected to reach 66%, which would represent a sharp deceleration in growth. However, Frank Slootman clarified in an interview with CNBC that management is conservative with advice. My projection for Snowflake product revenue in 2022 is approximately $2.05 billion (80% annual growth).

Snowflake Q4 2021 Results Presentation

Snowflake Q4 2021 Results Presentation

Why am I more optimistic than Snowflake management? Well, that’s because I don’t need sandbagging. With stronger than expected bookings on the platform from existing and new customers, Snowflake could easily exceed this conservative forecast. In Q4, Snowflake’s RPO grew to ~$2.65 billion (up ~100% YoY, up 47% YoY).

Snowflake Q4 2021 Results Presentation

Snowflake Q4 2021 Results Presentation

In the long run, Snowflake management guided FY29 sales to reach $10 billion, which would make Snowflake the fastest enterprise software company to reach this milestone. Although this forecast calls for a CAGR growth of around 30% for Snowflake after 2022, I believe that Snowflake could sustain a CAGR sales growth of around 50% over the next four years, and this revenue target of 10 billion could be reached in FY26 (3 years faster than management projections). My numbers are based on the secular tailwinds driving the shift in software spending to the cloud, and the expectation of a larger share for data management from annual cloud spending.

Snowflake Investor Presentation

Snowflake Investor Presentation

Snowflake Investor Presentation

Snowflake Investor Presentation

Although Snowflake’s management has opted for a non-GAAP FCF margin of only 15% long-term, I believe that figure will be much higher because Snowflake’s business is already operating at that level with a lot of leverage. operation to do with scale.

Snowflake management has clarified in the past that the company will not need to make any major acquisitions to meet its long-term financial projections. However, the company has significant market currency and enough cash on its balance sheet to drive inorganic growth. Along with its fourth quarter report, Snowflake released a press release announcing the acquisition of Streamlit. While this acquisition is unlikely to have a significant impact on Snowflake’s numbers in the near term, adding an open-source development framework to its platform is a huge boost for Snowflake.

Since Snowflake is already FCF positive (on a non-GAAP basis), I am not concerned about lack of profitability and believe Snowflake has minimal liquidity risk. Snowflake’s equity dilution (per year) is also less than 3%, so it’s worth it too. Overall, Snowflake’s business appears to be in great shape, and this financial situation may improve as quarters go by. Therefore, I would be a buyer at Snowflake if the price is right.

Now, let’s determine Snowflake’s fair value and expected returns to see if it’s a buy right now.

Evaluation and conclusion

Hypotheses:

Expected turnover over 12 months [A] (our estimate)

$2.05 billion

Potential free cash flow margin [B]

35%

Diluted average number of shares outstanding [C]

~310 million

Free cash flow per share [ D = (A * B) / C ]

$2.316

Growth rate of free cash flow per share (a reasonable estimate)

35%

Terminal growth rate

3%

Years of high growth

ten

Total number of years to boost

100

Discount rate (our “next best alternative”)

9.8%

Results:

LA Stevens Assessment Model

LA Stevens Assessment Model

By my estimation, Snowflake is worth $331 per share, i.e. it is currently undervalued by about 45%. Additionally, with Snowflake, investors could generate a CAGR of 23.47% over the next ten years. At $180 per share, Snowflake looks like a great buy.

LA Stevens Assessment Model

LA Stevens Assessment Model

However, the valuation of Snowflake (relatively high: > 30x P/S) could still compress further in the short term. And so, I think starting a small position here and following that purchase with a six to twelve month DCA plan would make sense. Snowflake is a high-quality growth company that could make up around 3-4% of growth-focused portfolios, and it’s now trading at a reasonable valuation. I would always buy a great company at a fair price and then a fair company at a bargain price. Therefore, I am happy to start accumulating Snowflake in the $180.

Key Takeaway: I consider Snowflake to be a $180 buy.

Thank you for reading and happy investing. Feel free to share your questions, thoughts or concerns in the comments section below.

Karen J. Nelson