Snowflake (SNOW 0.89%) is a cloud-based enterprise software company that revolves around data. Any business that wants to get the most value out of its data may find value in Snowflake's platform, and any investor attracted to top-line growth will appreciate the stock too.
Since going public in 2020, Snowflake's revenue growth has been superb -- few companies can even come close to matching this track record.
Data by YCharts.
Investors remain enthusiastic about Snowflake's growth potential, in part due to the artificial intelligence (AI) trend. AI excels at sifting through large datasets, so Snowflake is naturally seen as a beneficiary of this technology.
Financial results for its fiscal 2025 first quarter (ended April 30) seem to support this AI-based enthusiasm. During the quarter, Snowflake's product revenue grew 34% year over year to $790 million. That far surpassed expectations, and new CEO Sridhar Ramaswamy noted, "Our AI products, now generally available, are generating strong customer interest."
Investors liked that update, and some prominent analysts even raised their price targets for Snowflake stock as a result. However, when it comes to the AI revolution, there's one problem Snowflake investors might be overlooking.
Snowflake's AI headwind
Snowflake regularly provides financial guidance, and it just updated its outlook for the current year. Here's how its fiscal 2025 outlook compares to last year's results:
| Metric | Fiscal 2024 results | Fiscal 2025 outlook |
|---|---|---|
| Product revenue growth | 38% | 24% |
| Gross margin | 78% | 75% |
| Adjusted operating margin | 8% | 3% |
Source: Snowflake's investor presentation. Table by author.
When it comes to revenue growth, Snowflake actually raised its guidance from 22% to 24%. However, management lowered its expectations for gross margin (from 76%) and its adjusted operating margin (from 6%). And all three metrics are down from last year.
Snowflake's management explained the headwind: Building infrastructure for AI is expensive. This is why the company's margins are coming down. AI needs powerful graphics processing units (GPUs). Acquiring them is a cost of revenue, impacting gross profit, and there's also a recorded expense for GPUs in research and development.
In short, in order for Snowflake to offer its customers the AI applications they want, it has to build out powerful infrastructure, which doesn't come free. The company expects its profitability to take a hit this year as a result.
What's the alternative?
I don't want to overstate the headwind here. Snowflake isn't staring down a hurricane, just a breeze. And once this initial push with AI infrastructure spending is over, it's possible these GPU expenses will moderate.
Some might believe the AI trend is a once-in-a-lifetime opportunity, so Snowflake is right to spend heavily to secure its piece of the pie.
I'm not so sure.
It's true Snowflake needs to spend on AI to keep up with the competition. After all, some of its top competitors are tech giants, including Amazon, Microsoft, and Alphabet -- and those aren't companies it can afford to fall behind. It needs its AI capabilities to be just as good.
However, AI isn't necessarily something that will drive major growth for Snowflake, and the company's own financial guidance sheds light on this possibility. Management only expects approximately 19% growth for product revenue in the second half of fiscal 2025.
In other words, even with the supposed AI tailwind, Snowflake's growth rate continues to fall. AI applications are currently what customers expect, and all players in the space are offering something related to the technology. Therefore, AI isn't a growth driver unique to Snowflake -- it's merely something needed to avoid losing customers to a competing platform that does offer AI.
Putting it all together, the AI trend is more of a headwind for Snowflake right now than a tailwind. It's modestly elevating costs without an apparent benefit to growth. Unfortunately, there's no real alternative here. It's just the cost of doing business in a rapidly changing space where AI is all the rage.
Snowflake's shareholders should continue to track how AI spending affects expenses going forward. If margins continue to compress beyond this year, that would be reason for more concern.
Otherwise, keep expectations for Snowflake in check when it comes to AI. Yes, the company will be a player, but AI may just be table stakes in this industry rather than a powerful growth catalyst.
