Story Stocks^®

Data analysis platform provider Snowflake (SNOW) exceeded Q2 EPS and revenue expectations while also increasing its share repurchase authorization by $2.5 bln, but the stock is selling off sharply despite those positive headlines. The primary issue is that the company's guidance is being perceived as underwhelming, especially in light of the stock's rich valuation with a 1-year forward P/S of about 10.5x.

• For Q3, SNOW guided for product revenue of $850-$855 mln, which was only slightly ahead of expectations at the midpoint. More problematic, though, is that the midpoint of that guidance range equates to yr/yr growth of 22%, down materially from Q2's growth of 30%. 
• Although SNOW nudged its FY25 product revenue guidance higher by $56 mln to $3.356 bln, the increase failed to impressive investors, particularly since its Q2 product revenue came in about $20 mln ahead of estimates. Further adding to the disappointment, SNOW merely reaffirmed its non-GAAP operating margin guidance of 3%, even though its Q2 non-GAAP operating margin of 5% came in ahead of its guidance of 3%.
• Slowing growth and a pricey valuation can be a toxic combination, but adding rising expenses to the mix is just too much for the stock to overcome. As SNOW disclosed last quarter, the company is ramping up GPU-related investments in order to support the growth of new products, such as Cortex and Snowpark.
  • In Q2, R&D costs jumped by 39% to 437.7 mln, putting downward pressure on margins and non-GAAP EPS, which decreased by 18% yr/yr to $0.18. 
• On a brighter note, SNOW is excited about the momentum it's seeing on the new AI product front. Cortex Search and Cortex Analyst are expected to be generally available in Q3, and Snowpark is already beginning to contribute to the top-line. Snowpark allows customers to use programming languages, such as Python, Java, and Scala, within SNOW's cloud platform, eliminating the need to move data outside the platform for processing. This makes it easier, safer, and more efficient to deploy AI and machine learning models.
  •  SNOW's FY25 product revenue guidance of $3.356 bln includes contributions from Snowpark, which the company estimates at approximately $100 mln for the year.

The main takeaway is that business is still quite healthy for SNOW -- net revenue retention rate was 127% as of July 31, 2024, and remaining performance obligations grew by 48% yr/yr -- but the stock's rich valuation is hard to justify amid slowing product revenue growth and eroding operating margins.