Pure Storage Stock: What's next after another all-time high?
If you're wondering why Pure Storage stock is up 200% in the last 12 months, there's no getting around AI.
It is now almost exactly 5 years since I wrote the first share analysis on Pure Storage PSTG 0.00%↑ (in my role as a fund consultant at the time). If you are not yet familiar with this innovative provider of storage solutions, I recommend that you read the Pure Storage investment case from back then (here - in German) to get started.
A lot has happened since then, both in my own life (I retired from The Digital Leaders Funds in 2021) and at Pure Storage. Those of you who have stayed on as Pure Storage shareholders with me over the past 5 years have been richly rewarded for your patience after a long dry spell.
After tripling in the last 12 months, the Pure Storage share is currently trading at a new all-time high. Following the presentation of the figures for the first quarter of FY25, which runs until the end of January, the Pure Storage stock price has risen again. The investors in my investable sample portfolio are happy with me about a “five-bagger”, i.e. over 400% profit with the Pure Storage share.
Reason enough to take another critical look at whether the time for profit-taking might have come.
The Pure Storage quarterly figures for Q1 FY25
Pure Storage presented convincing figures for the seasonally weak first quarter of FY25 and clearly exceeded analysts' expectations.
However, the 18% revenue growth should also be seen in the context of a weak comparative quarter. In Q1 FY24, sales were actually down 5% on the previous year. Nevertheless, the return to double-digit growth is a nice success, after Pure Storage's sales in the past FY24 only increased by 3% compared to the previous year.
It should be noted that Pure Storage is selling more and more of its storage solutions on a subscription basis. This transition of revenue streams towards recurring revenues is currently still putting pressure on revenue growth. Subscription revenue increased by 23% to $346m in Q1 FY25 and increased its share of total revenue from 48% to 50% year-on-year.
Annualized subscription revenue (ARR = Annual Recurring Revenue) increased by 25% year-on-year to $1.4bn.
The operating margin improved significantly from 3% to 14.5% (non-GAAP). The gross margin improved further to just under 74% (non-GAAP).
Important to know: Pure Storage continues to invest considerable sums in research and development, and the R&D cost ratio of 20% (non-GAAP) is more in line with an innovative software company than a hardware provider. By comparison, the server provider Dell spends just 3% of its turnover on research and development.
The development of cash flow is very solid. In the difficult full year FY24, Pure Storage generated $483m in free cash flow, corresponding to a margin of 17%. In Q1 FY25, free cash flow increased by over 40% to $173m and the corresponding margin was a full 25%.
Pure Storage stock analysis - Guidance for FY25
For FY25, Pure Storage expects a return to double-digit growth and annual sales of at least $3.1bn after the meager 3% sales growth in FY24, which would be slightly more than 10% growth.
For the current 2nd quarter of FY25, 10% sales growth to $755m is expected.
The operating margin (non-GAAP) in FY25 is expected to be around 17%. GAAP profitability should also make significant progress. Analysts expect a good 5% net margin for FY25 compared to 2% in the previous year.
This is solid progress towards becoming a profitable growth company. But these figures alone are certainly not a reason for the tripling of the company's valuation in the last 12 months.
To better understand this share price movement, we need to take a broader view of the company:
Disk storage is a discontinued model
Modern flash memory, such as that offered by Pure, is becoming cheaper and cheaper (per storage unit). Since the launch of Pure FlashArray//E in 2023, the company has been able to offer flash storage for an unprecedentedly low $0.20 per GB including 3 years of service.
According to Pure management, this marks the point at which not only enterprise customers but also cloud providers are seriously considering the widespread use of flash storage as an alternative to traditional hard disk-based solutions for economic reasons.
Pure's FlashArray//E products for cost-effective mass storage of data save 80-90% of the space, power and cooling of a hard disk alternative. Energy efficiency is therefore becoming an increasingly important argument for the use of Pure Storage technologies.
We strongly believe that the days of the hard disk in the data center are over.
Charlie Giancarlo - Pure Storage CEO
Due to these new economic conditions, it is probably only a matter of time before cloud providers and data center operators begin to equip their systems with flash storage instead of hard disk systems on a larger scale.
As the technology leader for flash-based storage solutions, Pure Storage should benefit considerably from this market shift for years to come.
The role of Pure Storage in the AI hype
If you ask yourself why the Pure Storage share price has risen so much in the last 12 months of all times, then - of course - there is no getting around the topic of AI.
After all, it is nothing new that Pure Storage has been the technology leader in flash storage solutions for years and can supply the fastest and most energy-efficient storage components in the world.
And high-speed storage is of course also required when setting up the new data centers for Generative AI (GenAI) solutions. In other words, there is now a lot of AI fantasy in the Pure Storage share. Even if the size of the resulting business opportunities is rather sobering, at least at present.
We think that, probably in the past 12 months, about $1 billion was spent on storage specifically tied to AI training environments. Again, that might be a bit less than people expect.
Charlie Giancarlo - Pure Storage CEO
The AI topic could well accelerate the trend towards flash storage. More important for Pure Storage, however, is that the technological trend - away from hard disks and towards energy-saving and faster flash components - exists independently of the AI hype and is probably irreversible.
When will Hyperscalers buy?
Pure AI had already received a major order from Meta Platforms in 2022, i.e. before the triumph of generative AI. At the time, they equipped their AI Research SuperCluster (RSC), one of the fastest supercomputers in the world, with Pure Storage FlashArray components with a volume of 175 petabytes.
This first order for a so-called “Hyperscaler” was an important milestone for Pure. This is because the very large cloud computing providers such as Google, Microsoft Azure, AWS, etc. have not used flash storage to date for cost reasons, but instead rely primarily on cheaper hard disk storage systems.
Since then, there have been no further major orders from hyperscalers to report and analysts have become increasingly skeptical as to whether Pure Storage will really make it into the design of future hyperscaler data center architectures.
Pure CEO Charlie Giancarlo was extremely optimistic about this in the Q1 FY25 earnings call:
The quantity and quality of our discussions with hyperscalers have advanced considerably this past quarter. Our most advanced engagements now include both testing and commercial discussions. As such, we continue to believe we will see a design win this year.
To be honest, I am not very enthusiastic about such bullish statements from the CEO. Although this will boost the share price in the short term, it will put the company under extreme pressure to actually win a major hyperscaler order in the current financial year. If this is not delivered, the share price could come under considerable pressure.
Conservative corporate management certainly looks different. For me, such offensive communication by the CEO with the capital market is something of a (minor) warning sign.
High stock-based compensation for Pure Storage employees
I am equally unenthusiastic about the fact that Pure Storage continues to pay extremely high stock-based compensation 9 years after the IPO, which continues to lead to significant dilution.
The recorded (non-cash) compensation from stock options (SBC - Stock Based Compensation) amounted to a whopping $113m in Q1 FY25, which is 16% of sales.
The ongoing share buyback program was suspended in Q1 FY25, resulting in an increase in dilution to almost 5% in the past 12 months. In the last 6 years the existing shareholders have been diluted by almost 40%. That is far too much for my taste.
Why dilution is such a big issue for me?
When I discovered Pure Storage stock in 2019, the enterprise value was just $3 billion. Today, Pure Storage is priced at an enterprise value of over $18 billion, so that's a six-fold increase in the company's value over the past 5 years.
In fact, the share price at the time of my first analysis in 2019 was around $15. This means that the share has “only” quadrupled at a current price of $60 due to ongoing dilution.
Dilution matters!!!
Valuation of Pure Storage stock
Pure Storage's Enterprise Value (EV - simply explained here!) at a share price of $60 is approximately $18 billion. This implies an EV/Sales ratio of over 6 based on expected FY25 revenues.
Pure Storage shares have thus become extremely expensive over the past 12 months, not only in terms of share price but also on the basis of valuation multiples. Five years ago, I entered the company at a sales multiple of less than 2!
For the cash flow of the past 4 quarters, the EV/FCF ratio is 33.
After the jump in the share price, this valuation is extremely sporty for the storage technology leader. Even if it were to return to significant double-digit growth in the coming years. However, the high gross margins of well over 70% prove that Pure Storage is much more than just a hardware manufacturer and definitely deserves a correspondingly higher valuation like a software company.
A few months ago, Pure Storage was still significantly overweighted in my portfolio. I am delighted with a book profit of more than 400%. I have now already taken profits and thus reduced the overweight, as I expect a major correction (sooner or later).
Nevertheless, the Pure Storage stock remains in my sample portfolio as a smaller holding position. In the long term, the company could develop from a technology leader to a global storage market leader and thus grow into and beyond its high valuation.
*Disclaimer:
The author and/or associated persons or companies own shares in Pure Storage. This article is an expression of opinion and does not constitute any investment or financial advice.
Great article, Stefan! I knew the name, but didn't know much about the company.