The recent sell-off makes Pure Storage's valuation attractive.
Expanded opportunities in cloud storage will drive renewed interest.
Now is the time to acquire some position as macro sentiments improve from here.
Investors should take note of the growing short interest which has been fueled by the recent growth deceleration.
Pure Storage needs to improve other demand factors for volatility to reduce.
Pure Storage's (PSTG) growth narrative has been weakened due to softness in the storage space. The valuation has already baked in the weakness in the storage space. There is a wide execution window for Pure Storage to surprise the market in the near term. As a result, I have a bullish rating on Pure Storage's valuation.
Demand (Rating: Bullish)
Source: Call Slide
Pure Storage recorded revenue growth of 15% last quarter. The company is after a rapid market share expansion in a storage space that is recording weaker pricing power by enterprises. Pure Storage is differentiating itself via its cloud and AI-first approach. Though the storage space still faces a broad market drag, its shift towards cloud deployments keeps driving near-term growth.
Pure Storage is guiding for revenue of $1.64-1.65 billion (approx. 20% revenue growth) in 2020. This will be driven by demand for its shared storage service solutions and added TAM (total addressable market) in cloud storage.
Its expanded TAM means there is a wider run rate ahead of it. As a result, I remain bullish on demand for Pure Storage's solutions in the near term.
Business (Rating: Neutral)
Management expects pricing to moderate in the near term as FlashArray//C picks up the near-term softness. Remember, FlashArray//C is a cost-competitive alternative to FlashArray//X as reviews on TrustRadius and ITCentralStation indicate the pricing of PSTG's offerings are on the high side.
There isn't ample evidence that FlashArray//C, Pure as a Service, or Cloud Block Store will have a needle-moving impact on revenue in the near term. Though, they've helped accelerate Pure Storage's process of getting a foot into the door on key RFPs.
Near term, FlashArray//X and FlashBlade remain the key revenue driver. Until FlashArray//C becomes a significant portion of revenue, there will be immense pressure on its shared storage solutions to drive growth. The recent revenue miss, which was driven by not so favorable macro and pricing pressure, is a harbinger of what to expect near term.
Lastly, Pure Storage's balance sheet is attractive. The company has a cash balance of $1.24 billion and a total debt of $596 million, giving it a debt to equity ratio of 77%. As an investor, I will prefer to wait for a meaningful ramp in demand for its new offerings before giving the business a bullish rating.
Macro/Competitors (Rating: Neutral)
The storage space is facing a sector-wide macro headwind from the US trade war and pricing pressure as enterprises demand an improved total cost of ownership on their storage solutions.
Source: (Conference Call Transcript)
While Pure Storage's cloud/SaaS approach is compelling, the sector-wide pricing pressure hasn't shielded it from guiding softly. Soft guidance for a fast-growth company is a harbinger of a tough execution horizon. Competitors have the same comment about the headwinds. As a result, I am not confident in Pure Storage's macro and competitive positioning.
Valuation (Rating: Bullish)
The pricing and macro weaknesses in the storage space are already baked into Pure Storage's modest valuation. At 3x P/S (TTM), Pure Storage is reasonably valued.
Source: Author (using data from Seeking Alpha)
As it stands, investors only enjoy the growth quant factor if they acquire some position in Pure Storage. Pure Storage is not profitable, and its operating cash flow is a function of stock-based compensation. NetApp (NTAP) provides better exposure to key investing factors, given that both companies are exposed to the same macro and pricing issues.
Source: Seeking Alpha
Pure Storage's poor ROIC means it is reliant mostly on its growth factor to drive demand. Until other investing factors improve, Pure Storage will be vulnerable to the mania of growth investors.
Pure Storage's double-digit growth suggests little consumer risk. However, cloud platforms continue to dabble in the storage space thereby raising its competitive risk factor while weakening demand. According to the last 10-Q:
For instance, offerings from large public cloud providers are expanding quickly and may serve as alternatives to our products for a variety of customer workloads. Since these providers are known for developing storage systems internally, this trend could reduce the demand for storage systems developed by original equipment manufacturers, such as us.
As discusses earlier, execution risk depends on management's ability to improve ROIC. The recent macro and pricing volatility makes this a tougher feat to achieve. As a result, the investor-driven risk is bubbling.
The risk-reward highlights strong positioning for a sharp sell-off if its revenue doesn't meet near-term guidance. Unless you have a strong risk appetite, you should consider trimming your position.
Conclusion (Overall Rating: Bullish)
I don't expect a rebound in price action until demand from FlashArray//C becomes significant. Analysts aren't guiding too high. As a result, I expect Pure Storage to keep meeting its near-term growth targets.
The point of the recommendation scale is to simulate what other investors will do using the prevailing narrative for different investing styles. The dominant rating gives a strong color on what other investors are thinking. Investors can change their narrative and expected rating while sharing their insights in the comment section.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.