2023-11-16 17:17:27 ET
Summary
- Palantir Technologies Inc. revenue growth is slowing and market saturation becoming a concern.
- The company's profitability and cash flow remain positive, but the valuation is perhaps more expensive now as Wall Street shifts the metrics it will focus on.
- It is recommended to take significant profits and hold a small house position for long-term growth.
We have said it before, but stocks like Palantir Technologies Inc. ( PLTR ) are often extremely expensive in the early stages. While the company is still relatively young as a publicly traded entity, this company has been around a long time. We want to be very clear: we have rated this stock a buy twice this year, both times leading to sizable gains. We now hold what is known as a house position. We suggest investors consider doing the same if they came into Palantir Technologies stock this year and have substantial trading gains.
You can always buy more back, and we suspect you are certainly going to get the change. Palantir Technologies stock enjoyed wonderful momentum, but we believe heavy resistance in the 20-22 range is simply going to be too much to overcome with the growth that is being offered. There are a number of headwinds, despite this being one of our favorite plays in the innovation space and being unique. But this is about money, plain and simple.
Lock in your gains here at $20 a share, and leave a small position on to let run forever in your long-term account. This is a key approach we take to rolling trading gains into our long-term holdings for wealth creation. Simply put, there are other opportunities to now find outsized gains like the ones we have enjoyed.
Palantir's Growth In Question, But AI Had Reaccelerated Commercial Growth
This call comes as the just-reported third quarter earnings saw performance which was strong on the top and bottom lines and was ahead of consensus estimates . But the pace of revenue growth is slowing. That is a simple fact, as Palantir is starting to saturate the market. Yes there is room for more governments and more businesses, but lest ye forget, there are so many innovative companies battling for capex dollars of businesses, many competitors seeking to bring better decision-making and efficiency. While long-term we believe Palantir will grow into its valuation, we think the upside is capped near-term. As prudent traders, it is simply wise to take money off the table.
With that said, the pace of revenue growth is stalling. Last year, Palantir in Q3 we saw 22% revenue growth, which had slowed from 2021 growth. Well, Q3 2023 saw total revenue grow 16% year-over-year to $558 million, beating estimates slightly by $2 million. Palantir's profitability was better than expected by $0.01, and it led to a guidance increase for the year on the outperformance. That, combined with a massive rally in tech over the last two weeks, has led Palantir stock to climb so much and squeeze the shorts in the process that now there is a lot of resistance at present levels. The trend in earnings is definitely positive:
While it is positive that the company has clearly moved to being EPS profitable, and is still growing, the wild pace of growth has decayed and we suspect that the market will be looking to see just how strong 2024 will be before being able to break the stock through resistance. Either way, we will hold the house position.
But as you are likely aware, Palantir has two reporting segments in both the government and commercial segments, and the pace of growth had slowed. However Palantir generated $116 million in revenue in the U.S. commercial segment which was 33% increase over the same period the year before. That reacceleration stems from demand for Palantir's Artificial Intelligence Platform ((AIP)). Recall when we got you into the stock in the single digits we called it the real AI winner. After these levels of gains, it is prudent to take some off the table in our estimation.
The commercial sector is getting a short-term bump here in our opinion, while government results have been mixed for several quarters but is seeing some benefit from international strife. There are some concerns we have with backlog as well, but the company invested heavily in its sales and they have been working to secure new orders all year. Thus, the results we are seeing are with an expanded sales force. That is something to consider.
Bottom line here is that the deceleration of revenue growth overall is still a headwind for Palantir stock, and it is especially worrisome for a company like this that does not enjoy high earnings. Overall commercial growth was driven largely by the U.S., while the government sector has slowed to very low single digits.
We will also note that customer growth by count has slowed. While 34% year-over-year growth is certainly strong here, you can see regular growth of about 30 customers a quarter:
Palantir Q3 Business Update
What this does not show, however, and Palantir used to show, was the annual changes for Q3. This shows the last year. From Q3 2021 to Q3 2022, customer growth was 66%. So the rapid growth is certainly slowing. This is why it is crucial for the stock that the company continue to move further into profitability. If it fails too, the market will discount the growth in customers and revenues.
Make no mistake, this is solid performance. Were the stock at $8-$9, this would be a screaming buy. But the valuation is more than double this. Palantir is seeing very positive momentum in its margins as well. Positive movement in margins is important in a software company as it really highlights strengths, or weaknesses, in the way it distributes its products. Palantir is delivering. Gross margin continues to be strong, and this has been helped by a 20% reduction in stock-based compensation.
Positive Cash Flows Also Drove The Stock Higher
If there is one bullish point that really stands out, it is that Palantir remains cash flow positive. Adjusted free cash flow was $140 million for the quarter, and the 12th-straight quarter for which this was positive. The other major positive is that the company has $3.3 billion in cash and equivalents and no debt. This is why we are more than willing to hang on to a house position, but coming up into resistance and a still nosebleed valuation, the pressure is on.
Still expensive
On the valuation front, Palantir stock is really expensive. Given that the market will now be looking for ongoing EPS growth, not just sales and customer growth, the valuation looks really stretched at $20 per share. What was most surprising to us was the lack of really buying back stock when shares were depressed a few months ago.
With that said, the stock is here over 18 times trailing 12 month revenue and well over 15 times sales looking forward. That is fine for a company with rampant growth, but anticipated revenue growth of 18-20% is tough to justify such a valuation. The EV/EBITDA on a FWD basis is north of 60X with a price to cash flow over 75X. These valuations are hard to come by without wildfire-like growth. Instead, the growth is respectable, but shares are expensive, even if it is no fault of the performance.
The performance is quite good, but very tough to justify. We suspect that even with a guidance bump and expect pennies of EPS positivity in Q4, that the market is going to want more true EPS growth and will apply less weight to the aforementioned metrics.
Take home
So, on the bullish side for Palantir Technologies Inc., we have solid cash flow growth, we are earnings positive, margins have improved, and commercial growth reaccelerated. On the bearish side, the valuation is tough to justify, we have chart resistance ahead, slowing revenue growth rates, slowing customer growth rates, a still-high stock-based compensation issue, tons of competition, and to top it all off, a slowing economy which could reduce customer and government spend. We think it is more than prudent to take significant profit on Palantir Technologies Inc., and let the rest run as a house position.
For further details see:
Palantir Stock: This Party Is Over