Does Snowflake’s Stock Have 3x Upside?

Snowflake stock (NYSE: SNOW) has been on the negative side of investor interest in recent times, falling 40% in the current year and losing more than two-thirds of its value from its peak price of $392 in just three years. In contrast, the company’s topline performance has been fairly strong, growing by an average annual growth rate of 70% in this period, backed by its cloud data warehousing business that allows its customers to consolidate their data and generate insights. Trefis views cloud computing as one of the sunshine sectors that has grown tremendously in the recent past and promises more, going forward. But why is there so much negativity around Snowflake’s stock?  Despite its strong growth, the company has yet to report one quarter of positive earnings, which weighs on its market perception. This coupled with the management scaling down on its long-term revenue guidance caused further trouble in the current year.

What do the valuation multiples say?

At the current price level, Snowflake’s stock trades at about 12x trailing revenue. Is this pricey? Not at all. Especially if you consider the fact that the company’s revenues could be about 3.5x the current level in the next few years. Moreover, Snowflake’s current multiples remain low in historical terms. For perspective, when Snowflake stock debuted on the markets during the Covid-19 pandemic, it had a peak market cap of roughly $120 billion, while revenues stood at just about $1.2 billion in 2022, translating into a 100x price-to-sales multiple. Snowflake is likely to remain a key beneficiary of the continued pivot from on-premise databases to cloud-based warehousing solutions, which are seen as more cost-effective and scalable. Snowflake is a leader in this market, as its product works across multiple cloud platforms such as Amazon’s AWS, Google Cloud, and Azure, and also offers more flexibility, as it separates the billing of storage and computing. Snowflake’s lead in the cloud data warehousing market also positions it to benefit from growth in the generative AI space. The company’s  AI Data Cloud is used by over 10,000 companies to run their businesses with data, AI, and applications. The overall market serviced by Snowflake is also large, standing at about $152 billion in 2023, and is likely to grow to about $342 billion by 2028, per Gartner.  The company’s new product and application launches should also enable it to boost consumption and billings on its platform. Taking into consideration nearer-term forecasts, our estimates indicate that the stock is likely to have over-corrected to around $115 as against its fair value of $150 – Trefis’s estimate for Snowflakes’ valuation – indicating a near-term upside potential of 30%. But we are talking about a 3x upside over the longer horizon.

Does SNOW stock look attractive now?

Overall, the performance of SNOW stock with respect to the index has been quite volatile. Returns for the stock were 20% in 2021, -58% in 2022, and 39% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that SNOW underperformed the S&P in 2021 and 2022. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could SNOW continue to face a similar situation as it did in 2021 and 2022 and underperform the S&P over the next 12 months – or will it see a strong jump?

Growth is the key

With an increasing scale of operations, SNOW is also expected to steadily improve its business margins due to higher absorption of its fixed overheads, which would ultimately turn the company profitable at the net level. Hence pace of growth is the key here. If SNOW’s revenues grow by about 3.5x between FY’24 and FY’27, the P/S multiple will shrink to almost a fourth of its current level, assuming the stock price stays the same. But that’s exactly what Snowflake’s investors are betting will not happen! If sales expand 3.5x over the next few years, instead of the P/S shrinking from around 12x presently to ~3.4x, we think that the multiple could stand at about 10x – slightly below current levels. This could make a nearly 3x rise in Snowflake’s stock a real possibility in the coming years — with the stock rising to levels of over  $300.  With such growth, there is a high probability of the company registering positive net earnings within the next four-five years. In that sort of a scenario, the stock may have further upside surprises in store. What about the time horizon for this high-return scenario? In practice, it won’t make much difference whether it takes 3 years or 5 — as long as Snowflake is on this revenue expansion trajectory, with margins trending up and positive in the medium term, the stock price could respond similarly.

[1] Returns as of 9/30/2024
[2] Cumulative total returns since the end of 2016

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