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Snowflake Looks Like a Great Buy in This Stock Market Blizzard

After the largest software IPO of all time in September 2020, enterprise software provider Snowflake (NYSE: SNOW) has started to get the cold shoulder from its investors. While the first quarter illustrated robust revenue growth, primarily driven by improving unit economics of customer expansion, the stock is down over 50% year to date. However, since reporting earnings in late May, Snowflake stock has seen a modest uptick, up 16% in the last month.

Let's dig into the company's first-quarter financials, as well as management's commentary regarding future growth prospects. After analyzing the data, the picture may be more clear that Snowflake's current valuation could be a buying opportunity for long-term investors.

Image source: Getty Images.

A cold reaction to a hot first quarter

For the first quarter of fiscal 2023, which ended April 30, 2022, Snowflake reported total revenue of $422 million, an increase of 85% year over year. The majority of the company's revenue is derived from high-margin software (product revenue), while a less significant portion comes from lower-margin professional services.

Product revenue during the first quarter was $394 million, up 84% year over year. Perhaps even more encouraging was the company's expanding margin profile. For Q1, Snowflake's gross margin on its product revenue was 72%. By comparison, the product gross margin was 66% during the same period in the prior year.

Management addressed the company's ability to expand its margins in its investor presentation. While Snowflake boasted its pricing agreements with third-party cloud providers such as Amazon, Alphabet, and Microsoft, investors should not discount product improvements, which helped Snowflake expand existing accounts and scale its customer base.

Investors can see the direct impact of these product improvements in the company's key performance indicators. For example, Snowflake's net revenue retention rate increased from 168% at the end of fiscal Q1 2022 to 174% at the end of fiscal Q1 2023. Net revenue retention is an important metric for software companies because it measures how much the revenue base is growing net of churned accounts.

Although growing its existing base of customers is critical, Snowflake is also generating significant growth in new accounts. The company grew its customer base by 40% during the first quarter, ending April with over 6,300 accounts.

This growth has directly impacted another important metric called remaining performance obligations (RPO). RPO can help investors assess the momentum. Snowflake ended Q1 with $2.6 billion in remaining performance obligations, up 82% year over year.

Additionally, expanding its existing customers and penetrating new ones has allowed Snowflake to diversify its revenue mix. This table illustrates Snowflake's revenue mix over the last year.

Snowflake's Revenue Mix by Geography
Time Period Revenue, Americas Revenue, EMEA Revenue, APJ
Q1 FY 2022 84% 13% 3%
Q1 FY 2023 82% 14% 5%

Data source: Snowflake. EMEA stands for Europe, the Middle East, and Africa. APJ stands for Asia-Pacific and Japan.

Snowflake has done a nice job expanding its operations outside the U.S. Given the number of encouraging trends during the first quarter, investors may be a bit confused as to why the stock has seen such a sharp decline in its valuation this year.

What does the future hold?

While growing revenue by over 80% year over year and also expanding margins is impressive, some investors may fear that Snowflake is reaching peak performance. On the other hand, J.P. Morgan analyst Mark Murphy recently upgraded the stock from neutral to overweight and believes the stock could rise another 10% from current levels.

The primary concern among retail investors and Wall Street analysts alike is Snowflake's ability to continue its rapid customer expansion. Another way to look at this argument is to understand the company's revenue model. Snowflake offers a usage-based consumption model to its customers. As clients grow larger over time, they need more data capacity. Instead of selling subscriptions that expire after a specified period, Snowflake requires its customers to purchase additional storage in the form of larger data purchases.

Some in the investment community are concerned that Snowflake's ability to capitalize on this trend is plateauing. However, management has attempted to curtail these concerns by explaining that many customers are purchasing additional storage capacity within their initial contract terms. Moreover, Snowflake CEO Frank Slootman provided great detail about under-invested demographics such as federal opportunities, as well as new use cases that the company is yet to monetize.

Keep an eye on valuation

In July 2021, Snowflake was trading at a trailing-12-month price-to-sales (P/S) of 110 times. A year later, the company's current P/S has decreased to 31 times.

On the surface, the magnitude of this swing may be a cause for concern to investors. However, during a CNBC interview with Altimeter Capital CEO Brad Gerstner in early May, the investor reiterated that Snowflake's valuation had gotten ahead of itself during 2021. And while the stock has dropped precipitously, it still remains the largest position in his portfolio.

Gerstner urged investors to take a long-term investment horizon. Although the stock has dropped dramatically, the company is still generating robust revenue growth by expanding existing clients and signing new ones. As valuations reset during these volatile market conditions, Snowflake sticks out as an ideal buying opportunity for long-term investors.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Adam Spatacco has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Microsoft, and Snowflake Inc. The Motley Fool has a disclosure policy.


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