Palantir: Not A Clear Alpha Play Anymore

Seekingalpha2023-12-27

My earlier bullish thesis on Palantir has generated alpha but now I struggle to find a clear bullish thesis:A fall in RPO numbers increases top-line risk as revenue visibility is reduced.The S&P 500 ...

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Since publication, Palantir has delivered +14.61% compared to the S&P 500's (SPY) (SPX) +11.63%, leading to an alpha of +2.98% on a total shareholder return basis if you count till this article update today. However, the actual alpha captured was significantly higher at +18.03% as I had changed my stance to a 'hold' in an update comment in August 7, 2023. Since then, the stock has traded sideways, underperforming the S&P 500 by +9.11%.Now, I retain my 'hold' stance for the following reasons:A fall in RPO numbers increases top-line riskThe S&P 500 inclusion catalyst is likely priced inH2 FY23 net insider selling signals cautionValuations do not offer a sufficient discountA fall in RPO numbers increases top-line riskRemaining performance obligations (RPO) show us the value of both invoiced and yet to be invoiced work in a contract. It is a leading indicator of future revenues and cash flows for many technology companies.Palantir's RPO numbers have consistently been on the decline over the last 4 quarters.Remaining performance obligations YoY (Company Filings, Author's Analysis)For nominal context, incremental YoY decline amounts to an average of $215 million over the last 4 quarters:Remaining performance obligations YoY increment (in USD mn) (Company Filings, Author's Analysis)Digging further into this metric by comparing the next-twelve-month (NTM) RPO with beyond NTM RPO, we see that most of this decline is due to RPOs due over 1 year later. This is because the NTM RPO YoY is still growing slightly:Remaining performance obligations recognized over NTM YoY (Company Filings, Author's Analysis)But the beyond NTM RPOs have been declining at almost 40% over the last 3 quarters:Remaining performance obligations recognized beyond NTM YoY (Company Filings, Author's Analysis)For context, NTM RPOs have consistently made up 53-58% of the overall RPO mix.When combining these numbers with clues from management's narrative;3/4 of our quarter-over-quarter growth is from customers that started with us in 2023.- CRO Ryan Taylor on Palantir's direct commercial growth profile in the Q3 FY23 earnings call.I infer that Palantir's top-line makeup is shifting more towards more smaller deal conversions and relatively fewer larger projects that offer greater revenue visibility. Hence, the leading RPO metrics may be showing a fall due to reduced visibility. To be clear, I do not believe this spells a negative outlook on Palantir's revenue growth as a whole. Rather, I think it increases the risk in top-line expectations for investors as there are fewer locked in contracts.The S&P 500 inclusion catalyst is likely priced inA key thesis point and monitorable I discussed in my last article was the company's march towards Q3 FY23 profitability, which would make it eligible for S&P 500 index inclusion.Due to consistent improvements in operating margins,Normalized EBIT Margin (Company Filings, Author's Analysis)which has translated into TTM GAAP profitability,TTM GAAP Net Income to Common Shareholders (USD mn) (Company Filings, Author's Analysis)Palantir is now fully eligible for S&P 500 inclusion. I believe this is a likely event since the company's market capitalization of almost $38 billion is already much bigger than nearly 300 of the 500 stocks in the S&P 500 (SPY) (SPX).Moreover, the margin improvement and positive profitability status can be considered to be a highly sustainable one not only because management has indicated so, but because incremental operating margins are still very high at above 100%:Incremental YoY Normalized EBIT Margin (Company Filings, Author's Analysis)This is significant as it is a very strong indicator of a long runway of continued margin improvements.However, I believe the market was already anticipating S&P 500 inclusion earlier in the year and although this bullish event has not materialized yet, it is likely to be priced in the stock. This is because of the \"Disappearing Index Effect\" in today's stock markets; data which proves that index inclusion catalysts provide no real edge when index inclusion criteria are already met.H2 FY23 net insider selling signals cautionPalantir 2023 Net Insider Selling by Officers Value (USD mn) (Company Filings, Author's Analysis)According to Open Insider, Palantir's key personnel have ramped up their personal sales of PLTR stock in the second half of 2023. Compared to H1 FY23, which saw $75 million in net insider selling, company insiders have sold H2 FY23 has seen almost 112% higher insider selling at $160 million. I view this as a cautionary sign for bullish views on the stock.Valuations do not offer a sufficient discountI continue to believe that Palantir's growth prospects are strong. However, with reduced top-line visibility and expiration of previous catalysts such as index-inclusion, I would demand a sizeable discount for buying the stock.However, looking at the 1-yr fwd PE multiples, the stock seems to be trading around fair value at 59.6x, which implies a 3.8% premium to the longer term 1-yr fwd PE of 57.4x.Palantir 1-yr forward PE (Capital IQ, Author's Analysis)Key Risks and MonitorablesThe revenue visibility from longer term contracts may be less but this does not in any way preclude future revenue surprises. For example, I calculate that the $115 million extension deal with the US Army would lead to an incremental 13.4% YoY bump up in RPOs for Q4 FY23. But that is only if nothing else changes. In reality, it is difficult to say whether there are contract expirations without renewals or extensions to offset the positive development here. Moreover, this $115 million deal is a 1-year extension and hence it does nothing to alleviate the more important issue of RPO visibility beyond the NTM. Overall, I will be keeping a close eye on the RPO figure and its breakup in Q4 FY23 results as that would be a vital piece of feedback for my thesis.On the insider activity side of things, I am not looking for evidence of insider buys to signal bullishness as past data suggests there is minimal insider buying. Instead, I would need to see low insider selling activity coupled with new catalysts in the stock for me to act bullishly again.TakeawayIn summary, my earlier thesis on Palantir has played out with alpha of >20% vs the S&P 500 if one includes the article update comment made in August 2023.Now, I don't see a clear bullish thesis anymore in the stock. Instead, the leading top-line indicators point towards lower visibility particularly beyond the next twelve months. Data says the S&P 500 inclusion catalyst is old news and unlikely to lead to any appreciation in the stock even if the event has not materialized yet. More aggressive insider selling activity in H2 2023 is another sign of caution for the bulls. Given these arguments and the absence of a discount in the 1-yr fwd PEs, I believe Palantir is not a clear alpha play anymore.How to interpret Hunting Alpha's ratings:Strong Buy: Expect the company to outperform the S&P 500 on a total shareholder return basis, with higher than usual confidenceBuy: Expect the company to outperform the S&P 500 on a total shareholder return basisNeutral/hold: Expect the company to perform in-line with the S&P 500 on a total shareholder return basisSell: Expect the company to underperform the S&P 500 on a total shareholder return basisStrong Sell: Expect the company to underperform the S&P 500 on a total shareholder return basis, with higher than usual confidence","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":9,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2394732247"}