2023-12-20 09:30:00 ET
Summary
- In today's article, I want to look at Palantir Technologies Inc. with no initial bias in order to understand its growth prospects.
- I find that the acceleration of Palantir Technologies' sales growth could be much more sustainable than I previously thought.
- Palantir's long-term EPS growth (7-year CAGR) of 23.7% is 456 b.p. above the median of the sample I use for comparison.
- The company's FY2030 price-to-earnings ratio is ~10.3% higher than the median, while FY2025 EV/EBITDA is even higher (by ~28%).
- I'm upgrading Palantir Technologies Inc. stock from 'Sell' to 'Hold,' which means that I'm neutral on the stock until I see a margin of safety in it.
I've been covering Palantir Technologies Inc. (PLTR) for years and have always been very skeptical about the company. My sell thesis worked fine throughout 2022, but the rise of new artificial intelligence, or AI, technologies gave the company's shares a huge boost, as did the development of its internal operational processes, which revived the growth rates of sales, EBITDA, and earnings per share figures.
Many analysts, once they have issued a rating, stick to it for a very long time, even when the fundamentals change dramatically and the whole thesis no longer makes sense. I have to admit that I suffer from this "analyst disease" myself from time to time - perhaps this is the disease I experienced in the case of PLTR when the stock started to recover on faster-than-expected EPS growth rates and I continued to view it as just another "rip."
In today's article, however, I want to look at the company with no initial bias in order to understand its growth prospects and what at first glance appears to be a high valuation.
Palantir's Operations Growth And Financials
The recent financial quarter ( Q3 FY2023 ) became Palantir's 4th consecutive quarter of GAAP profitability. The company closed 80 deals of $1 million or more across 30 industries, according to the press release. The U.S. commercial business grew 33% year-over-year, with a significant impact from customers that started with Palantir in 2023. The U.S. commercial customer count rose by 12% QoQ, reaching 10x the count of just 3 years ago.
The company highlighted the success of its go-to-market approach around the AIP (Apollo Intelligence Platform) bootcamps, which made it possible to create real workflows with real customer data in five days or less. This resulted in faster time-to-value for customers, IT stakeholder engagement, and a greater number of companies working with PLTR. By the end of November, the company had conducted boot camps for over 140 organizations, almost half of them that month alone.
During the Q3 earnings call , Palantir emphasized the vast improvements in unit economics from initial contact to customer conversion. It helped PLTR to achieve a reacceleration in revenue growth, reaching $558 million in Q3, reflecting a 17% YoY increase and a 5% sequential uptick.
Of particular note, the U.S. commercial business demonstrated substantial growth, expanding by 33% YoY. The company is focusing on conquering the health industry with its new boot camps, breaking my old assumption of a further slowdown in sales growth.
Adjusted gross margin stood at an impressive 82%, excluding stock-based compensation ("SBC") expense. Moreover, the adjusted EBIT margin reached 29%, surpassing expectations and marking the 4th consecutive quarter of expanding margins.
But my old assumption that PLTR is dependent on SBC still holds. Moreover, PLTR's shares outstanding kept going even higher than I expected:
The positive thing on this front is that the company has finally generated positive cash flow excluding SBC, which is not comparable to what we saw last year:
Another concern that lies on the surface is rising DSO, as another Seeking Alpha analyst, Ironside Research, noted in his analysis earlier this month . And indeed, PLTR's DSO is rising much faster than what we are seeing in the industry. In case you don't know, DSO measures the average number of days it takes for a company to collect payment after a sale has been made. So, an increasing DSO suggests that cash is tied up in accounts receivable for a more extended period. But in absolute terms, the ratio appears to be in line with norms (maybe slightly higher).
In addition, the growth in this metric may be related to the revenue stream shift that the company is currently undergoing, so the net impact of this increase on future sales growth remains to be seen, in my view.
Looking at the company's financials and plans for scaling operations in healthcare and other areas of their Commercial segment, I see that the acceleration of PLTR's sales growth could be much more sustainable than I previously thought.
But will this growth be enough to grow out of the current valuation multiples?
Palantir Stock Is Not As Expensive As You Think
During the time I've been covering PLTR stock here on Seeking Alpha, I've tried many valuation models to value the stock: discounted cash flow ("DCF"), absolute and relative valuation multiples, the sum of the parts ("SOTP") - you name it. Today, I want to show you my next development based on a combination of COMPS and future financial data (expectations). I have taken several companies that are similar in nature of operations to compare with PLTR. I even included Nvidia (NVDA) in this list, which is not a direct peer to PLTR, but roughly represents the same sector.
What do I look at? First of all, the P/E ratio. Many say that PLTR's P/E ratio is too high, while the bulls say that PLTR is a growth company whose P/E ratio is irrelevant. In my opinion, both camps should meet in the middle: When evaluating a growth stock, I propose looking at the long-term P/E ratio and long-term EPS growth together. By long-term EPS growth, I mean Wall Street's projections for the company's earnings in a few years, and by long-term P/E ratio, I mean the implied valuation multiple (e.g., EPS in FY2030 divided by today's market capitalization).
So, what do we have on our 2D dot plot?
PLTR appears to be a fairly valued company with a projected long-term EPS growth (7-year CAGR) of 23.7%, which is 456 basis points above the median of the sample. The company's FY2030 price-to-earnings ratio is ~10.3% higher than the median, but this appears to be offset by the EPS growth.
Now let's look at the EV/EBITDA ratio and the growth of the underlying. Let's not think ahead to 2030, but stop at 2025. In 2025, PLTR's EBITDA is expected to grow by 25.4% year-on-year (i.e., compared to FY2024), resulting in an implied EV/EBITDA ratio of 37.08x for FY2025 - that's a lot. But that's only at first glance, because compared to other companies in the industry, PLTR's dot is below the trend line, quite close to the median value:
Palantir has turned out to be not as expensive as I initially thought, but on the other hand, I can’t say that the stock is cheap, either.
The fact is that PLTR's EV/EBITDA is ~28% higher than peers' growth, while its projected EBITDA growth in FY2025 is only 3% higher (25.4% vs. median of 22.4%).
Conclusion
To be honest, I find it difficult to remain bearish on PLTR stock today. When I look at the company's latest financial results, I realize that they are completely different from what I expected a year ago (or even earlier this year). Palantir Technologies Inc.'s business is growing much faster, and it seems that the company has found another lever for growth through its bootcamps and thanks to its focus on the healthcare industry.
The valuation of the stock doesn't seem too high if we look at PLTR multiples through the lens of future EPS growth. There are certain issues with EBITDA-related multiples, but still, Palantir seems to be close to its fair value despite the seemingly high multiples. However, my findings are based only on comparative analysis and consensus estimates, which are subject to change at any time. We cannot rule out the possibility that the entire industry is overvalued today - soft landing or not, when the period of multiple contraction comes, PLTR will be one of the first to fall. A multiple contraction seems to me to be one of the most likely scenarios for next year, but that is a topic for a full-length macro report.
Based on the above, I'm upgrading Palantir Technologies Inc. stock from "Sell" to "Hold," which means that I'm neutral on the stock until I see a margin of safety in it.
Thanks for reading!
For further details see:
Palantir Stock: Hard To Stay Bearish (Rating Upgrade)