2023-11-02 12:20:37 ET
Summary
- Palantir Technologies Inc. reported strong quarterly earnings and expects better-than-expected results for the current quarter and year.
- The company's shares jumped by close to 20% and speculation about potential S&P 500 inclusion is a tailwind.
- Palantir's business growth is solid, with revenue growth close to 20% and profitability improving due to cost-cutting efforts and operating leverage.
Article Thesis
Palantir Technologies Inc. ( PLTR ) reported strong Q3 earnings results and has guided to better-than-expected results for the current quarter and year. The company's shares jumped by close to 20%, while speculation about potential S&P 500 (SP500) inclusion also was a tailwind for the company's shares.
What Happened?
Palantir Technologies has announced its most recent quarterly earnings results on Thursday morning, prior to the market's opening. The headline numbers can be seen in the following screencap from Seeking Alpha:
We see that the company beat estimates on both lines, which is, of course, a great result. The beats weren't dramatic, but the company nevertheless outperformed expectations.
While revenue growth wasn't as strong as it was a couple of years ago, it still was compelling, at close to 20%. Especially when we consider the tough macro environment where some companies are reluctant to increase their spending and where many governments are struggling with large deficits and rising interest rates, a high-single-digit business growth rate is pretty solid.
Palantir Technologies' profitability, or lack thereof, had been a major bearish argument in the past. But more recently, Palantir Technologies started to generate better and better profits, thanks to factors such as cost-cutting efforts and operating leverage -- operating expenses tend to decline on a relative basis (e.g., versus revenues) as a company grows. This has been clearly visible at Palantir, which benefits from operating leverage to a significant degree. I expect the same will hold true in the coming quarters and years, which is why it seems likely that PLTR's profits will climb faster than its revenues in the foreseeable future, too. Especially among tech companies, this is a common theme, as proportional expenses are rather small, and since many expenses -- e.g., for development and research -- are fixed or semi-fixed, rising revenues have an outsized positive impact on the company's profits.
Palantir Technologies: Appealing Business Growth
Palantir Technologies is doing business with government agencies and customers, but the company is also doing business with enterprises and other commercial customers.
Many of Palantir's government contracts are defense-oriented. This makes for a strong and recession-resilient base business with longer-term growth potential, as AI and data analysis will likely become more important for militaries and defense departments over time. Overall defense spending should also grow in the long run, especially when we consider the many crises and conflicts around the world today.
But on the other hand, government contracts can be lumpy, and processes can be slow -- it takes quite some time for contracts to get approved, thus growth is not very fast.
This is why it is a good thing that Palantir is also doing business with non-government parties. These do not only expand PLTR's market potential drastically, but forging contracts can also be a lot quicker, and business growth can thus be more agile. Palantir helps all kinds of companies make their operations more resilient and/or more efficient, e.g., by optimizing supply chains via data analysis, or by helping mining and energy companies in optimizing their exploration. Since these processes can generate a lot of value for Palantir's customers, it is likely that they will stick with the company in the long run when they are happy with the results -- and it seems realistic to me that they will also try to expand their cooperation over time as long as the results are positive.
Palantir Technologies continues to add new commercial customers at an attractive rate. During the most recent quarter, the company saw its U.S. commercial customer count expand by a hefty 37%, relative to one year earlier. The company's offerings and products thus seem to attract businesses and enterprises at an increasing rate, which is why more and more companies sign up to do business with Palantir. The positive news about the results of projects PLTR has done with other customers likely plays a major role in explaining why more and more companies decide to do the same by entering partnerships with Palantir as well.
Many of these new customers will start out with smaller projects in order to get to know Palantir and in order to forge a basis of cooperation, with contract volumes then expanding over time.
Commercial revenue growth has been compelling as well, at 33% for the U.S. business, relative to one year earlier. It looks like growth is accelerating, as revenues were up by 13% compared to the previous quarter -- which pencils out to an annualized growth rate of well north of 50%. Of course, there is no guarantee that the growth rate will remain this high, but momentum seems to be on Palantir's side for now.
When Palantir agrees to a deal with a new customer, it can't recognize all of the future revenue immediately. That's why other metrics, such as total contract value and the number of closed deals, are important as well, as they indicate where the company is headed. Both looked pretty good:
- - Palantir's TCV was a little north of $250 million, up more than 50% year over year, suggesting the backlog keeps growing at a hefty pace that is not 100% reflected under GAAP revenue numbers.
- - Palantir's number of new deals closed during the quarter was slightly ahead of 100, which was up more than 60% compared to the previous quarter. This, again, suggests momentum is strong -- the ongoing AI theme and increased focus on that could explain why Palantir is doing more and more new contracts.
Palantir Technologies has been widely criticized for its share-based compensation, or SBC, in the past. SBC explained why there was a big gap between the company's GAAP profits and its adjusted profits, where SBC is backed out. However, over time, the share issuance has slowed down, and GAAP profits improved considerably. The company has now been GAAP profitable for four quarters in a row -- which is a nice feat all by itself, considering Palantir is still a rather young growth company. But the four quarters of GAAP profits could also be important due to another factor: PLTR is now eligible for S&P 500 ((SP500)) inclusion.
What Could S&P 500 Index Inclusion Mean For Palantir Technologies?
Only companies that have generated positive GAAP profit results over four quarters in a row are eligible to be included in the S&P 500 index. A company that has a market capitalization that is large enough for S&P 500 inclusion and that achieves GAAP profitability for four quarters in a row for the first time thus sometimes experiences major share price gains. A very good example of that is Tesla ( TSLA ), which saw its shares soar when it first became eligible for an S&P 500 spot. When the company eventually was included and index-replicating ETFs were forced to buy shares of the company, shares experienced further gains.
In November of 2020, it was announced that Tesla would join the index. Over the following year, Tesla saw its shares explode upwards -- they were up by around 200% at one point. There is, of course, no guarantee that the same will happen to Palantir. In fact, I believe that a gain this large is unlikely -- Tesla is a bit of a unique stock due to a lot of emotionality, and the broad EV hype during the pandemic had an impact on its soaring stock as well. Still, even if the impact of a potential S&P 500 inclusion of PLTR would be less pronounced, it would most likely be positive -- just one-tenth of the impact seen at Tesla would still allow for double-digit gains.
It is thus not surprising that the market reacted quite positively to Palantir's results and the statement about S&P 500 inclusion legibility.
Is PLTR A Good Investment?
Palantir Technologies Inc. business growth looks good, margins are improving, the balance sheet is pretty strong, and potential S&P 500 inclusion could be a tailwind for Palantir over the coming months.
That being said, the company has experienced hefty gains over the last year and is now a lot more expensive than it was at the beginning of the year. I wrote a bullish article on Palantir in February , giving it a "Buy" rating. Since then, shares are up well above 100%, which is nice for those who held it over that time frame, but which also means that buying now comes at a much higher price. I prefer to buy shares when they are on the cheaper side, which is why I am not adding shares today, despite liking the progress Palantir Technologies Inc. has made.
For further details see:
Palantir Soars On Strong Guidance And Index Inclusion Speculation