Snowflake Earnings: Questionable Free Cash Flow Guidance, Slowing Customer Adoption

Summary

• Snowflake's guidance points to its topline slowing down from a more than 100% run rate to less than 70% CAGR for the year ahead.
• A discussion of Snowflake's taxes on management's compensation package, and how this nearly equals Snowflake's total free cash flow for the year.
• Investing is always about odds. And anyone that thinks otherwise is deluding themselves. And the odds here don't look enticing.
• Looking for a helping hand in the market? Members of Deep Value Returns get exclusive ideas and guidance to navigate any climate. Learn More »

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Investment Thesis

Snowflake (NYSE:SNOW) negatively surprises investors that it is indeed slowing down. Investors had come to assume that Snowflake would probably continue growing at close to 100% CAGR for a few more years.

During fiscal 2022, Snowflake's taxes on management's stock options were essentially equal to the total amount of free cash flow the company made during fiscal 2022.

Furthermore, new customers' onboarding is slowing down.

The odds of this investment look less than satisfactory. I believe that investors would do well to avoid buying more of this name.

Note, Snowflake's fiscal year and calendar year are misaligned. I'll only refer to its fiscal year.

Investor Sentiment Turns Negative For SNOW Stock

Data by YCharts

As tech stocks sold off, Snowflake remained largely stable. Investors continued to welcome the alluring narrative of Snowflake's incredibly high retention rates, which we'll address lower down.

The thing with investing is that one is always working off incomplete information. You never really know what you don't know. It's always a game of odds, and anyone that thinks otherwise won't last long in this investment journey.

Snowflake's Revenue Growth Rates Slow Down

Snowflake revenue growth rates

As you can see above, the full-year guide points to Snowflake growing by approximately 67% y/y. Now, please note that this only includes the product revenue, and it does not include the professional services segment.

However, nobody reading this is investing in Snowflake for its professional services segment. Not only are those revenues not sticky, but they are growing by just 6% y/y, and that side of the business is meaningfully unprofitable. That's not where the bull case lies.

This is the fact: Snowflake's fiscal 2023 guidance is clearly below the exit rates from Q4 2021, where revenues were up more than 100% y/y.

Now, before everyone starts declaring that Snowflake is lowballing estimates to allow for easy beats down the road, allow me to remind readers that Snowflake only beat its Q4 2022 revenue consensus estimate by 3%.

This figure of a low single-digit beat is a stark departure from its historical overperformance.

Snowflake's historical revenue beats

As you can see above, historically Snowflake easily beat consensus by high single-digits, whereas now the beat was only by 3%.

Why Snowflake?

Snowflake is a cloud platform that connects data and shares with its customers.

Snowflake allows companies to break down data silos, build data-driven applications, share data inside and outside of their organizations without latency.

As organizations grow and more customers use Snowflake's Data Cloud, a network effect is created as more data can be exchanged with other Snowflake customers for data engineering, data science, and data application development.

Snowflake Q4 2022 investor presentation

Altogether, this leads to Snowflake's insanely strong pricing power that is reflected in its net retention rates reaching 178% during fiscal 2022. That's where the bull case lies.

That being said, as I've always argued, don't overly focus on revenues, follow the customer. The customer knows best. What follows is the increase in total customer growth rates. See if you can spot a trend:

• Q4 2021: 73% y/y
• Q1 2022: 67% y/y
• Q2 2022: 60% y/y
• Q3 2022: 52% y/y
• Q4 2022: 44% y/y

I believe that this trend highlights an undeniable fact. Snowflake's ability to onboard new customers is slowing down.

Next, we'll discuss its profitability profile.

Path to Profitability is Now Snowflake's Focus

There are good and bad elements to consider in Snowflake's profitability profile.

Snowflake Q4 2022 investor presentation

The good news is that Snowflake appears to be pointing towards becoming increasingly profitable as it progresses into fiscal 2023.

The bad news is that the market has increasingly punished stocks that are ''growing at any cost''.

Then, to further complicate matters, the company's free cash flow profile is nowhere near as strong as it first appears. Allow me to explain:

Snowflake Q4 2022 investor presentation

During its press statement, Snowflake consistently points out to investors about its 12% adjusted free cash flow margins. However, as you can see above, that figure adds back the taxes that the company pays on management's stock compensation.

I'll repeat this to drive the point home, there's absolutely no way that management's tax-related payment is not an expense.

For fiscal 2022, the taxes associated with management's compensation package was $69 million which was very close to Snowflake's free cash flow of $82 million during fiscal 2022.

Thus, it could be nearly argued that all of the company's free cash flow for fiscal 2022 was used to pay the taxes on management's stock options.

Snowflake Q4 2022 investor presentation

In that light, the fact that Snowflake is guiding for 300 basis points expansion at the midpoint for fiscal 2023 doesn't look all that compelling.

SNOW Stock Valuation - Don't Buy the Dip

As we look ahead, Snowflake is valued at approximately 38x forward sales (if we include the after-hours sell-off of 20%).

This time last year, this would have appeared expensive but egregious.

But when there are now countless companies out there that are expected to be growing at approximately 50-60% CAGR priced meaningfully below 15x forward sales and sometimes even lower, it simply makes no sense to pay such a large multiple for Snowflake, particularly if its revenue growth rate is starting to slow down.

After all, the business isn't even that profitable, as we've discussed above. The bulk of the business' profits goes back to management anyway.

The Bottom Line

Investing is never easy and investing is never obvious. You are always working off incomplete information as an outsider attempting to make the best investment decision you can with the information available at odds that leave with you an ample margin of safety.

I fail to see how Snowflake offers investors enough margin of safety. And I know that investors would much rather stand behind the mantra of ''buy and hold forever'' rather than reassess their investment thesis.

But you are left with a clear choice now:

• You can either reassess your choice now.
• Or you can do it much later at a lower valuation.

As for me, I'm going to deploy my own capital into investments that have a more compelling risk-reward profile. Whatever you decide, good luck and happy investing.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.