We realize that we need to be better about sharing content on our blog. And so, what better place to pick up the slack than with one of our top buys for 2024, PureStorage, which seems to be catching a fresh tailwind as the data center AI market heats up? This post was originally one of our videos on YouTube that published on April 1, 2024, with these show notes available over on our Discord channel (just $5 a month). Here’s a sampling of what you can find over there…

Our first video about PureStorage June 2023: https://youtu.be/c2XPlli4HHU 

The last video on PureStorage and the data center memory server market: https://youtu.be/R5maOmfOsvo 

2024 top chip stocks video from December 2023: https://youtu.be/RiKEDDCG9nI 

PureStorage (NYSE:PSTG), one of Kasey’s top picks for the start of 2024, has been off to the races since we last discussed it in mid-December. But it’s time to revisit our buy thesis, because it seems the market has decided (like us) that Pure’s “missed” guidance for 2023 is a-OK.

The PureStorage business model advantage

PureStorage isn’t a “semiconductor stock” directly. Rather, it’s a tech equipment/hardware designer specializing in all-flash NAND memory storage servers. The company acquires memory components (like from Micron (NASDAQ:MU), for example), and utilizes third-party contract manufacturers to build its product. Pure focuses on the engineering of these data center storage devices, as well as software its customers need to operate them.

https://d18rn0p25nwr6d.cloudfront.net/CIK-0001474432/ed7936ac-e0cd-408a-ae7f-063381fdf3a1.pdf pg 10 of FY2024 annual report

While some of its data center server competitors are well-diversified, Pure’s co-founder and Chief Visionary Officer (and still one of its largest shareholders John Colgrove) founded the business on the belief that flash memory was the future. Data storage (memory) is one of the three primary components of any computing system, alongside logic and networking. 

Flash memory is based on solid-state semiconductors, or NAND flash memory. Traditionally, long-term storage was built with hard-disk drives (HDDs) that utilize mechanical parts to access the data stored on it. HDDs, being the older technology, are cheap to deploy for mass storage, but lack the high performance of memory chips. Pure buys its flash memory chips from the likes of Micron (which holds a narrow lead in NAND flash memory tech), Samsung and SKhynix, or Western Digital (NASDAQ:WDC).

You can see that the manufacturing process for NAND isn’t entirely dissimilar from the 3D stacking of DRAM chips to make HBM3e (high-bandwidth memory), used for short-term memory used in Nvidia’s (NASDAQ:NVDA) GPU AI systems. Link to our last videos on that topic here: https://youtu.be/Rmz3GpexOrs https://www.youtube.com/watch?v=X4nzgs78LII time stamp 8:22

At any rate, the end result for PureStorage is a business fully dedicated to propelling the world’s data centers towards all-flash storage. And in fact, some of Pure’s lower-performance all-flash systems (for the budget conscious customer) have reached cost-parity with some of those old HDD systems. 

Thanks to the software engineering creating a single operating platform (the Purity Operating Software) regardless of how a customer deploys these storage servers, Pure boasts some of the best total cost of ownership (TCO) in the industry.

https://d18rn0p25nwr6d.cloudfront.net/CIK-0001474432/ed7936ac-e0cd-408a-ae7f-063381fdf3a1.pdf pg 6 of FY2024 annual report

Pure’s advantage, simply stated by CEO Charles Giancarlo:

“This year, we expanded our Evergreen portfolio and increased subscription services revenue now to over 40% of total revenue. FY ’24 total contract value sales for Evergreen//One and Evergreen//Flex grew to over $400 million, more than doubling over the prior year. Product and platform innovation was strong as evidenced by FlashBlade now exceeding $2 billion in total sales since launch.

FlashBlade continues to serve as the leading platform for customers’ modern file and object data requirements for both high performance and low-cost applications. Launched just 9 months ago, our new E family of products achieved the fastest sales growth of any pure product, presaging that Flash will soon replace all disk.

Our data storage platform strategy and vision is working and continues to succeed with large enterprises and managed service providers. Pure’s strategy to consolidate data storage using a single operating and management environment for the majority of storage requirements just makes more sense than managing multiple different and disparate system environments. Pure’s DirectFlash reliability and economics continue to be unmatched and customers appreciate our Evergreen guarantee of no application downtime with system upgrades.

Pure’s platform strategy incorporating Pure Fusion, which enables Pure systems to operate as a distributed storage cloud, combines the best features of enterprise storage with cloud agility and programmability. It enables customers to manage their data environment as unified storage pools, seamlessly spanning across data centers and public cloud platforms, all within a single operating and management framework. Pure allows customers to organize their data infrastructure efficiently and optimize their data environment.”

How does Pure stack against the competition?

Of course, what has really helped PureStorage stand out from a financial perspective (versus just a technological one) is the subscription model that’s building atop those traditional storage server sales (when a customer buys the storage equipment outright). 

Pure’s growing software capabilities have allowed it to steadily increase its recurring subscription revenue base, which has helped offset some of the more cyclical swings its legacy competitors have faced (excluding Super Micro Computer (NASDAQ:SMCI), which is making most of its hay these days from AI servers).

You can see these subscriptions steadily building to 43% of total revenue this year. We expect the company could cross the 50% subscription revenue milestone by the end of this year (calendar year 2024 or early 2025).

Data source: Pure Storage. 

A bet on growing high-performance data needs in the genAI era

But what does long-term storage of data have to do with AI? CEO Giancarlo again on this matter:

“However, what truly excites me about AI, confirmed through conversations with customers and partners, is the focus that it is bringing to customers fragmented data environments. Customers are beginning to realize that their current fragmented data storage environment will significantly hinder their ability to leverage AI to unlock the full potential of their data.

Current data storage environments inhibit AI deployments in 2 ways. First, existing data storage arrays were selected to provide just enough performance for their primary function, leaving little performance left for AI access. Second, existing storage arrays are not networked, limiting access to AI apps not provisioned directly on their primary compute stack.

The Pure Storage platform solves both of these issues. Pure’s E-family delivers Flash reliability and efficiency at prices now comparable to traditional hard disk systems and with plenty of performance there for AI access.

And the single operating and management environment of the Pure platform across protocols and price performance ranges makes accessing data easier. We are also seeing increased numbers of Portworx deployments in AI environments for data management preparation. Portworx had a record year and accelerated growth based on customers increasingly graduating their container-based development projects to production scale.”

In other words, as AI increases the need for on-demand access to long-term data (not just the short term storage embedded via advanced DRAM devices in a GPU system), the flexibility Pure offers customers in deploying and upgrading systems, on-premises or in the cloud, has some serious advantages in this new AI era.

Why did the stock rally? Valuation notes for 2024

Let’s revisit what’s happened in the last six months. Remember the stock price dipping late in 2023? That was due to Pure reporting lower-than-predicted revenue. The reason had to do with subscription purchases coming in higher than originally expected. Since a subscription sale is realized over time, versus the bigger lump-sum payment when a customer purchases a storage server outright, Pure’s revenue growth took a hit (3% revenue growth in fiscal 2024, versus mid- to high-single-digit % growth originally forecasted).

There were also macroeconomic factors at play as well as customers continuing to manage their own spending to try and boost their own profitability. But ultimately, higher subscriptions is a short-term drag on top line growth, one that investors should have been fine with. It ultimately led to slightly higher adjusted operating profit margins last year (in the blue circle above), and more revenue getting realized later on. Fiscal 2025 (the 12 months that will end in January 2025) implies ~10.5% revenue growth to ~$3.1 billion. Adjusted operating margins are also expected to tick higher again, to ~17%.

Is the valuation now too high?

After a great start to the year, the question naturally becomes, “Is it too late to buy?” Here’s what we think the market’s consensus expectations are for PureStorage over the long-term, using a very simple reverse discounted cash flow (DCF) model. Bear in mind this doesn’t factor for the sizable amount of cash and short-term investments ($1.53 billion) and minimal debt ($100 million) that could be deployed in numerous ways to promote further profitable growth.

Given these assumptions (mid- to high-single-digit % revenue growth, paired with margin expansion, to get to a low-teens % profit-per-share growth rate), we view PureStorage as fairly valued at the beginning of April 2024 – not the value stock we saw in December 2023 after a significant selloff. We are more than happy to continue holding our position, and will be on the lookout for opportunities to accumulate more if the positive story continues to progress in 2024. 

Video link: https://youtu.be/wjwfbhUVarE