Should One Consider Purchasing Snowflake Shares Presently?
Should One Consider Purchasing Snowflake Shares Presently?
Amidst the intense competition in the enterprise software market, specifically the shift towards AI-driven work, Snowflake's reputation as a high-performing business has remained robust. The data platform surpassed predictions for its first quarter of fiscal 2025, with product revenue increasing 34% year on year (originally forecasting a growth of 26%-27%). Moreover, the company raised its yearly forecast, expecting product revenue growth of 24% (previously 22%).
However, there were reasons for caution in this report. The escalating costs of business growth in the AI era are mounting, primarily benefiting Nvidia at present. Although I was optimistic about investing in Snowflake three months ago, I'm now reconsidering my stance.
The price tag of keeping pace with AI-powered counterparts
Snowflake's recent revenue boost and subsequent upgrading of its full-year guidance suggest that the software market has recovered from the significant dip in 2023. Despite Snowflake's expected 24% growth rate for this financial year, which is a decrease compared to the 38% growth rate of the previous year, this is an achievable target for a company generating over $3 billion in annualized sales.
However, digging deeper into the financials reveals a different story. In this AI-focused era, enterprise software companies are under pressure from a new direction: the escalating expenses of procuring Nvidia's GPU-powered AI systems.
During the last earnings call, Snowflake's CFO Michael Scarpelli stated:
We are adjusting our full-year margin guidance due to increased costs related to our AI initiatives, stemming from GPU investments. We consider these investments crucial for unlocking future revenue opportunities. Let me remind you that we have GPU-related expenses in both cost of revenue and R&D.
Specifically, Snowflake has demand for Nvidia's hardware. The company requires these systems for training and enhancing new AI services, such as the launch of Cortex (an AI tool for users of big data), Arctic LLM (a large-language model), and Snowpark (announced last summer in collaboration with Nvidia).
In summary, the costs associated with these Nvidia GPU systems are rising, causing Snowflake to revise its guidance for adjusted operating profit and free-cash-flow profit margins for this year. The anticipated adjusted operating margin now stands at 3%, while the free-cash-flow margin is expected to be 26% (previously 29%).
More patience required
Slower revenue growth and declining profit margins, even if the adjusted and free-cash-flow profits increase in absolute terms, is less than ideal in this market. As a consequence of the revised guidance, Snowflake's stock value remains relatively stable, as it has in recent months.
In the meantime, there are other software stocks with the optimal balance of growth and expanding profit margins. I'm beginning to question my decision to purchase a small amount of Snowflake stock a few months ago, given the stock's current pricing at 6 times trailing-12-month free cash flow. Some patience will be required as the company works on another round of AI-boosted data management software innovation.
It appears that the same situation persists, much like it has since the Snowflake IPO in 2020. The company is currently priced too expensively for the investor community's collective comfort. Perhaps as signs emerge that profit margins begin to climb once again, the narrative will change.
After considering the rising costs of procuring Nvidia's GPU-powered AI systems, which are necessary for Snowflake's AI initiatives, I'm rethinking my investment strategy. These expenses have caused Snowflake to revise its financial guidance, resulting in lower expected adjusted operating and free-cash-flow profit margins for the year.
Given the current economy and the increased expenses due to AI investments, I believe more patience is required to see if Snowflake's profit margins start to climb again, making the investment more financially viable.