Pure Storage: Overvalued Data Firm With Long-Term Growth Potential Fueled By AI

seekingalpha09-16 18:10

Pure Storage saw YoY top & bottom line growth in fiscal Q2, and both company and analysts expect future growth.Very low debt-to-equity ratio vs peers, low interest expenses and long-term debt low vs ...

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Fueled By AI\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-09-16 18:10 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4721294-pure-storage-overvalued-data-firm-with-long-term-growth-potential-fueled-by-ai><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Pure Storage saw YoY top & bottom line growth in fiscal Q2, and both company and analysts expect future growth.Very low debt-to-equity ratio vs peers, low interest expenses and long-term debt low vs ...</p>\n\n<a href=\"https://seekingalpha.com/article/4721294-pure-storage-overvalued-data-firm-with-long-term-growth-potential-fueled-by-ai\">Source 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Leading Data Storage & Solutions Provider Today's article takes a break from my recent coverage of the financial sector and jumps into the tech scene again, as I discuss Pure Storage (NYSE:PSTG). As I get ready to attend a major tech conference in a few days which will talk a lot about artificial intelligence/AI, as well as trends relevant to developers, let's take a moment to think about where all that data goes and gets stored. According to the official site of Pure Storage, their company works to \"store, manage, and protect the world's data.\" The business case this firm offers to clients, with their Pure Storage platform, includes reducing operating costs, energy savings, and reducing downtime of data, since downtime can certainly have a business impact.. something those of us who have worked in the IT sector know well. Rather than going into detailed descriptions of all their offerings, however, I will summarize and say they offer a portfolio of products and solutions as well as services and training/certifications. Some of their distribution channels also include resellers and partner alliances such as with system integrators and managed solutions providers. From SA data on peers, the three comparable peers I will use today to compare this firm against will be Lenovo (OTCPK:LNVGY), Seagate Technology (STX), and Western Digital (WDC). For instance, Lenovo also has a data management and storage business and on its own website said the following: Data is the new currency of business and holds the key to unlocking valuable insights to help you grow your business and compete more effectively in the marketplace. With that said, let's talk next about this firm's recent earnings and what could drive future performance and affect share price. A Positive Top & Bottom Line Outlook A glance at the income statement tells us 2 of the last 5 quarters saw a net loss, and the quarter ending August (Q2 of fiscal 2025) saw a YoY improvement to earnings, as well as a YoY improvement to top-line revenue, while we'll have to wait until Nov. 29th for the next earnings release. Looking ahead, the analyst consensus is estimating an EPS of 1.63 for fiscal year ending Jan. 2025, for a +16% YoY growth, with 12 upward analyst revisions and just 4 downward. The company itself is forecasting nearly 7% revenue growth guidance for Q3, according to their Q2 presentation: Pure Storage - Q3 revenue guidance (company) Personally, I am of the opinion that with this specific type of business a key driver of future revenue stability and growth to think about is recent and current growth in subscription-based customers, since recurring subscriptions can drive future revenue. The following few graphics from the Q2 presentation show indicators that not only are customers growing but subscriptions are growing steady as well. Pure Storage - customer growth (company)Pure Storage - growth in subscription revenue (company) Besides top-line projected growth, let's consider impacts to the bottom line next. For one thing, their operating expenses growth on an annual and quarterly basis have generally been flat. For example, research and development costs have been between 18.6% - 19.7% of revenue in the last 3 years, as seen in the graphic below: Pure Storage - operating expenses (company) The other item I want to mention is interest expense, since we are in a high rate environment, and this company's balance sheet shows the firm sits on about $100MM of long-term debt. The good news is that quarterly interest expenses have been generally steady since Aug. 2023, at around $2MM per quarter. Pure Storage - interest expense (company q2 presentation) Hence, if there is a start to Fed interest rate reductions soon, and it pans out into next year, leading to overall lower interest costs in the economy, I think it will have a minimal impact on this firm's earnings but certainly does not hurt either. In terms of the sector this firm is in, peers like Western Digital and Seagate have already reported growth in demand in some of its segments such as flash memory and chips. Here is what a late July article in Reuters said:  Revenue of the company's (Western Digital) flash memory business.. rose nearly 28% to $1.76 billion. Rival Seagate Technology forecast upbeat revenue for its first quarter last week, driven by increased demand for memory chips from personal computing and data center clients.  From the evidence, my impression is that the positive analyst forecasts are justified and top-line revenue will be driven by current subscribers and demand growth, while expenses remain sustainable. That leads into our next topic, and that is some risk factors to consider with this stock. A Healthy Debt Profile & Large Potential Market to Serve Those of us who grew up during the dotcom boom and bust of the late 1990s / early 2000s, or have worked in tech in some way, know that it is a sector constantly prone to change, and companies/brands that have come and gone, but also technologies that have changed with the years.. going from software in a box to essentially cloud-everything, requiring continuing adaptability and re-learning. For example, here is what Corporate Finance Institute said on this topic of the dotcom bubble: Several online and technology entities declared bankruptcy and faced liquidation – namely Pets.co., Webvan, 360Networks, Boo.com, eToys, etc. However, other internet-based companies struggled but survived and are giants today, notably Microsoft, Amazon, eBay, Qualcomm, and Cisco. With that said, as a potential investor in Pure Storage obviously I want it to be one of the \"survivors\" in this highly competitive market. This will depend on capturing enough market share, and continued growth of this specific market itself, its key segment being data storage. According to data site Statista, back in 2022 firms like Dell, NetApp, and HP Enterprise (HPE) had the largest market share of the storage segment, with Seagate and Lenovo capturing nearly 10% of the market each at the time. Statista - market share of storage market (Statista) From more recent data in July 2024, we also know from Statista that the storage market worldwide has steadily grown since 2017 and is projected to be worth $101B by 2029, as the chart below shows. Statista - data storage market growth (Statista) This data sets the backdrop for Pure Storage to potentially penetrate all that market potential out there in the next decade and beyond, despite competition, since it is such a large multi-billion dollar global market. More importantly, Pure Storage is taking advantage of the so-called \"AI revolution.\" According to its Q2 press release: Pure Storage continued to accelerate enterprise AI adoption, announcing that it will be a certified storage solution for NVIDIA DGX SuperPOD by the end of 2024. Additionally, Pure joined the Ultra Ethernet Consortium (UEC), a Linux Foundation initiative, underscoring its commitment to expanding the capabilities of high performance Ethernet for large-scale AI and HPC initiatives. What I see is a firm that is well positioned to take advantage of a huge market looking ahead, while at the same time having the lowest debt-to-equity ratio (0.06) of the three peers I selected, as evidenced by the chart below, placing it in what I consider a very low debt risk. Data by YCharts With penetration of a huge market, a low debt-to-equity, and positive cashflow, I am leaning towards being bullish on this stock. However, is the price and valuation justified? Let's talk about that next. Overvalued but Dipping Below its Moving Average Now that we have a better picture of this firm, we can talk about price and valuation. First, we can see from the following YChart that as of this article's writing the stock was trading at $48.90, or about 4% below its 200-day SMA, after what appears to be a recent price dip below the moving average. Data by YCharts In terms of valuation, SA data tells us this company is extremely overvalued vs its overall sector in terms of P/E and P/B ratios. Drilling down more precisely, the following compares the forward P/E of this stock with 4 peers, as I also added Logitech (LOGI) this time, and we can see Pure Storage is much more overvalued at a forward P/E multiple of 29.9. Data by YCharts Using my comparable companies analysis below, a share price in line with the peer average forward P/E multiple would put this stock's share price at $23.42, yet currently it is trading at $48.90 (a $25 premium).   comps analysis (author sheet) Is it justified to be trading at a $25 premium? While I have shown evidence that it has strong fundamentals, I think this valuation is a bit excessive, considering the competition in this space which provide a lot of similar products and solutions, or have the capacity to. Impression: Hold On For Further Price Drop To wrap up, here are some positive points we discovered about Pure Storage today: Q2 saw YoY growth on the top and bottom line, it has very low debt-to-equity and low interest costs while having just $100MM in long-term debt on $3.7B in total assets. Both the company and analyst consensus have positive future guidance powered by recurring subscriber revenue, and there is a huge AI-driven market to penetrate for the next decade which has proven to be growing. At the same time, despite taking a dip below its 200-day average it is trading at a $25 premium to its peer average forward earnings multiple, and I should mention it is not a dividend-paying stock either, which is a disappointment as a dividend-income investor. My holistic clinical impression is therefore neutral on this one, calling it a hold and awaiting the price to come down at least another $10 to $15, which is a fair value price I would buy it at. Though I think the market is somewhat justified in overvaluing this one, likely driven by strong future guidance, I still am cautious to call it a buy at this price due to its market position trailing behind other, bigger tech leaders in this space. For instance, industry portal CIO Influence placed it 3rd in top 20 enterprise data storage providers for 2024, behind NetApp (NTAP) and Amazon Web Services (AMZN).  With that said, I expect great things for Pure Storage in the next decade, and am ready to pick up some shares, but not at the current price. I welcome readers' comments on whether you also consider it overvalued and why or why not? 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