2023-11-15 09:18:41 ET
Summary
- Palantir's stock price has tripled this year due to strong fundamental results and optimism over generative AI.
- The question for investors now is whether the rally can continue amidst higher interest rates. I recommend staying long, but moderating your position.
- Consensus is pointing to revenue growth accelerating in FY24, backed up by the company's hopes that U.S. government trends will pick back up.
- At ~15x forward revenue, Palantir's stock prices in a lot of strength.
Palantir ( PLTR ) has been one of the most successful stocks in my portfolio all year. The famed AI category leader has seen its share price more than triple from the start of the year after a bruising 2022, driven both by strong fundamental results and the wave of optimism over generative AI.
The core question for investors now, amidst higher interest rates that threaten to cast a pall on valuations, is: can the Palantir rally keep going?
The bull case for Palantir is still vibrant, but be cognizant of its rich valuation
I last wrote a bullish note on Palantir in September, when the stock was trading closer to $15 per share. I issued a price target of $18 on the stock at the time, representing a 13x forward revenue multiple.
Now, with the latest interest rate-driven rally, Palantir has burst well beyond this target. As I've previously written, I have been long on Palantir since its IPO at $10 per share, and used last year's tremendous, overreactive dip as an opportunity to substantially increase my position. Now, with Palantir at $20, I'm taking a similar approach to de-risk my position, selling off roughly a third of my holdings, while still remaining bullish overall.
Valuation is the major driver behind my decision. Amid 5%+ risk-free interest rates, I want to lower my portfolio exposure to richly-valued tech stocks and park a little more into cash, to take advantage of a potential market dip. At current share prices just below $20, Palantir trades at a market cap of $43.48 billion. After we net off the $3.28 billion of cash on Palantir's most recent balance sheet, the company's resulting enterprise value is $40.20 billion.
Meanwhile, for next year FY24, Wall Street analysts are expecting Palantir to generate $2.66 billion in revenue, representing 20% y/y growth (which would be an acceleration from current growth rates, in-line with the company's expectations that the U.S. government business will re-accelerate beyond current trends: more on that in the next section). Against this revenue target, Palantir trades at 15.1x EV/FY24 revenue - which I think approaches the peak of what this company can sustain in the near term. Mid-teens valuation multiples have become incredibly rare (this year's rally has not returned tech stocks back to COVID-era valuation levels, and rightly so given where interest rates are sitting), especially for a company expecting ~20% growth.
That being said: a lot of Palantir's opportunity sits further into the future as AI adoption accelerates, so it's worth looking at the longer term and not giving too much consideration weight to near-term valuation multiples. Here is my full long-term bull case on Palantir:
- Palantir's AI/big data applications have tremendous variety in use cases. Palantir isn't a software company that serves only one or a limited set of use cases. Data and inferences that can be made from data are prevalent in just about everything: which explains why Palantir is such a powerful tool for both public and private sector clients. Big data is also the feeder to AI, as the two work hand in hand.
- Stepping up go-to-market momentum, especially in the commercial segment- Palantir is chasing growth across a wide variety of channels. The company has stepped up its sales hiring, a nod at the broad market opportunity it has and the need for more territory coverage. Palantir also has deepened relationships with ISVs (integrated service vendors) that can resell Palantir's products without its involvement and offer additional coverage that Palantir's direct sales force can't handle. The company's growing base of commercial revenue also proves out that there is plenty of untapped market opportunity even in the small/midsize business space.
- Free cash flow and GAAP profitability- Palantir has maintained GAAP profitability for several quarters and continues to generate healthy free cash flow, which means the business is self-financing (a departure from many other rapid-growth software companies that continue to need to raise capital to finance their losses).
- Strong balance sheet- Palantir has over $3 billion of net cash on its balance sheet, which gives it plenty of financial flexibility to pursue buybacks and acquisitions for growth if it so chooses.
The net recommendation here: I continue to believe in upside for Palantir in 2024, but don't put all of your eggs in this basket after the stock has tripled this year. Monitor stock movements regularly and diversify your portfolio appropriately after this year's outsized gains.
Q3 download
Palantir's recent Q3 results jolted additional enthusiasm in the stock, especially after management noted its hope for stronger government performance in 2024.
The Q3 earnings summary is shown below:
Palantir Q3 results (Palantir Q3 earnings deck)
Palantir's revenue grew 17% y/y to $558.2 million, ahead of Wall Street's expectations of $556.0 million. Growth also accelerated slightly over Q2's 13% y/y revenue growth, which was foreshadowed by Q2's incredibly strong billings linearity.
Commercial revenue continues to be the major growth engine for Palantir, with revenue up 23% y/y to $251 million:
Palantir commercial vs. government revenue (Palantir Q3 earnings deck)
Meanwhile, overall commercial customers grew by 28 sequentially to 330, while the company also increased total customers by 32:
Palantir customer counts (Palantir Q3 earnings deck)
The company noted that large deal paces have accelerated, and that the lead times for both conversion and expansion have shortened - which is opposite commentary to what other software companies have noted, with the tough macro environment generally constraining IT budgets and delaying projects.
Still, what investors latched on to was the hope that U.S. government revenue (still more than 40% of overall revenue with $229 million of contribution in Q3) would accelerate beyond Q3's 10% y/y growth rate. Per Chief Revenue Officer Ryan Taylor's remarks on the Q3 earnings call:
We expect our U.S. government business to reaccelerate beyond the current growth rate of 10% year-over-year, given increasing demand for those products to support our allies around the world. While we continue to expect near-term uncertainty given budgetary environments, we were encouraged by the pickup in activity at the end of the U.S. government fiscal year, and we feel well positioned for long-term growth through our evolving strategy, which Sean will speak to further.
Just several weeks ago, it was announced that the Army awarded us a new contract worth up to $250 million over three years to provide additional capabilities in support of COCOMs, armed services, intelligence community and special forces as they continue to test, utilize and scale AI and ML capabilities."
From a billings basis: Q3 billings of $550 million decelerated to 8% y/y, but that's largely a function of the fact that a generous amount of billings pulled into Q2, which spurred a 52% y/y growth rate last quarter. Taken together, the two quarters represent 27% y/y billings growth, more similar to 25% y/y growth in Q1 and helping to support a ~20% revenue growth rate in FY24 per consensus estimates.
Palantir billings (Palantir Q3 earnings deck)
And from a profitability standpoint, the company achieved its fourth sequential quarter of GAAP profitability, with net income nearly tripling sequentially to $71.5 million.
Palantir profitability (Palantir Q3 earnings deck)
Adjusted EBITDA margins rose 13 points to 31%, while free cash flow in the YTD more than tripled to $425.8 million, representing 17 points to FCF margin expansion to 26%:
Palantir FCF (Palantir Q3 earnings deck)
Key takeaways
I've enjoyed the sharp rally in my Palantir position, but exercising caution amid a potentially frothy market is key to preserving capital. Stay long here, but monitor this stock regularly and don't be overly exposed to premium tech stocks in this environment.
For further details see:
Palantir: I'm Still Bullish, But De-Risking My Position All The Same