To The Moon

$Pure Storage(PSTG)$

Hey, everyone! Welcome back. Today, I want to talk about one of my favorite companies of 2024—Pure Storage. By the end of the year, I was feeling pretty optimistic about it. However, as you've probably noticed, the market has taken a serious hit recently, and Pure Storage hasn't been spared. Its stock has seen a significant decline over the past week. Given this downturn, you might be wondering what a Chip Stock investor is doing with their position. That’s exactly what we’ll discuss today, along with the company’s outlook for the coming year.

Where Pure Storage Fits in the Tech Landscape

To refresh your memory, Pure Storage falls under the broad category of tech equipment and devices. It specializes in assembling storage systems, distinguishing itself from memory IDMs (Integrated Device Manufacturers), which produce the core components that go into storage solutions. Think of Pure Storage as the chef who takes raw ingredients and transforms them into a fully prepared meal—in this case, a storage server.

What sets Pure Storage apart is its accompanying software suite, which enhances the functionality of its storage hardware. This software is a crucial element of the company’s overall success.

Pure Storage started as a hardware company, primarily known for its flash storage hardware solutions. It designs and sells high-performance all-flash storage arrays, which are used by enterprises, cloud providers, and AI/data-driven companies. But it is transforming into a hybrid model with an increasing emphasis on software and services. The subscription-based offerings provide predictable recurring revenue, which investors and enterprises find attractive. Although hardware remains a significant part of its business, Pure Storage is expanding its recurring revenue model through software and subscription-based services:

Earning Overview

Pure Storage, Inc. (NYSE: PSTG) reported its fiscal fourth-quarter 2024 earnings on February 28, 2024. The company achieved non-GAAP earnings per share (EPS) of $0.50, surpassing analyst expectations of $0.45. However, this represents a slight decrease from the $0.53 EPS reported in the same quarter of the previous year.

Total revenues for the quarter were $789.8 million, marking a 3% decline compared to the same period last year. Despite this decrease, revenues exceeded expectations by 1%. The company's subscription services, particularly Evergreen//One and Portworx, continued to show strong demand, contributing to these results.

Fundamental Analysis

The company's ability to secure long-term customer commitments is reflected in its 24.8% average ARR growth over the past two years. Over the last five years, incremental sales have driven strong profitability, with earnings per share growing at an impressive 46.4% annually, outpacing revenue growth.

Pure Storage (PSTG) generates substantial free cash flow, providing flexibility to invest in growth initiatives or return capital to shareholders. Additionally, its increasing cash conversion enhances its margin of safety.

The Subscription Growth Factor

Looking at the last five years, Pure Storage’s subscription revenue has steadily increased, now making up 52% of total revenue in fiscal year 2025, which just concluded. Management noted that higher direct sales of storage server hardware last year slightly slowed subscription growth, but overall, the trend remains strong.

The Bigger Picture: Storage in Computing and Cloud Services

When you think about computing and cloud services, it helps to compare them to a utility company—always in demand. The vast amounts of data and computing power required for daily work, streaming, and even watching cat and dog videos require significant storage capacity. Traditionally, this data has been stored on hard disk drives, but Pure Storage is pushing forward with its flash-based solutions.

Guidance

For the full fiscal year 2024, Pure Storage reported revenues of $2.8 billion, reflecting a 3% year-over-year increase. Subscription services revenues grew by 26% year-over-year, reaching $1.2 billion. The total contract value (TCV) sales for Evergreen//One and Evergreen//Flex exceeded $400 million during this period.

Once again, Pure Storage has emphasized that revenue from the hyperscaler deal won’t contribute meaningfully until 2026. In the meantime, the company plans to increase its operating investments in fiscal 2026 to scale operations and expand opportunities—both with this hyperscaler and potentially with other similar customers.

It’s also important to note that this partnership focuses on technology licensing and support services rather than hardware sales. If you haven’t seen our video on IP and licensing, I’ll link it here—it’s a great resource on why this aspect of the semiconductor industry can drive higher profit margins.

Free Cash Flow

In terms of cash flow, Pure Storage ended the fiscal fourth quarter with $1.5 billion in cash, cash equivalents, and marketable securities, up from $1.35 billion in the previous quarter. The company generated $244.4 million in cash flow from operations during the quarter, compared to $158.4 million in the same period last year. Free cash flow was $200.9 million, up from $113.3 million year-over-year.

Despite these positive figures, Pure Storage's stock experienced a decline of over 14% to $53.20 following the earnings release. This drop was attributed to mixed future guidance and concerns over gross margins, which fell to 69.2%. While revenue and guidance for the upcoming quarter and fiscal year were in line with expectations, operating income projections fell short, leading to investor apprehension.

With these increased investments, Pure Storage’s free cash flow margin has declined, though its GAAP operating profit margin remains slightly positive at just over 3%. Over time, we expect both of these metrics to converge, with a target of exceeding 20% margins on both fronts.

Stock Buybacks and Portfolio Considerations

Pure Storage repurchased a substantial $580 million worth of shares last fiscal year, bringing free cash flow per share to $1.54. However, these buybacks have primarily offset employee stock-based compensation.

So, what does all of this mean for Investor’s position in Pure Storage? And what should you consider for your portfolio? We’ll dive into that next.

Risks and Challenges

Dependence on Cloud & AI Growth Pure Storage is benefiting from AI and cloud computing trends, but any slowdown in these sectors could impact demand for its products. If enterprises reduce investment in AI-driven workloads, the company may see lower sales growth.

Economic Slowdown & IT Budget Cuts Many businesses have reduced IT spending due to macroeconomic uncertainty. If companies cut back on cloud storage and enterprise IT investments, Pure Storage’s revenue growth could be affected.

Gross Margin Pressure While Pure Storage has strong revenues, its gross margins have declined. This could be due to pricing pressures, higher costs of materials, or changes in product mix, which may impact profitability.

Valuation

Looking back at our valuation notes from December, Pure Storage was trading around $65 per share, with a market cap of $21 billion. At that time, the company was valued at 30x its expected free cash flow for the year. Our reverse discounted cash flow (DCF) analysis indicated that a fair value of $65 per share implied a 15% free cash flow per share growth rate over the next five years. If you missed that December video, I recommend checking it out for a deeper dive into these metrics.

Now, let’s assess the current valuation. Unfortunately, the stock has dropped to approximately $49 per share, bringing its market cap down to $16 billion. Pure Storage is now trading at about 29x expected free cash flow for the current year.

From a balance sheet perspective, the company remains financially strong, with:

• $1.5 billion in cash and short-term investments

• $100 million in debt—an overall clean balance sheet

So, what does our updated reverse DCF tell us?

At a $49 per share valuation, the market is now pricing in a 10.5% free cash flow per share growth rate for the next five years—down from 15% in December. This analysis assumes:

• 6% terminal growth rate

• 10% discount rate

Is this reasonable? maybe.

Market sentiment

Recent Developments and Hyperscaler Partnership

Public cloud providers offer plenty of flash storage to cloud infrastructure customers. However, many internal cloud workloads still rely heavily on hard disk drives (HDDs). Last quarter, Pure Storage announced a significant deal with one of the top four hyperscalers, partnering with Kioxia to transition more data storage from HDDs to flash storage.

Discussing this development during the latest earnings call, CEO Charlie Giancarlo stated that the partnership is progressing well, with the next phases focused on testing and deployment plans. Pure Storage continues to advance its certification process across various price-performance tiers, enabling the hyperscaler to adopt a unified architecture across multiple levels of its storage hierarchy.

This shift will also allow the hyperscaler to reallocate power and space to new workloads while improving storage performance, reliability, and longevity. We covered the importance of this deal for hyperscalers in our previous Pure Storage video, which I’ll link here.

It’s worth noting that while this partnership is promising, management has made it clear that meaningful revenue from this agreement won’t materialize until at least 2026. However, the market appears to be looking for more immediate results.

Conclusion

For those considering Pure Storage for their portfolio, better wait for a good entry point. However, we recommend keeping the position small and taking a patient approach. The company have little profit Margin.

Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.

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