Why It Is Difficult To Justify Palantir's Stock Price

Seekingalpha2023-11-29

Palantir reported solid third quarter results, but top-line growth is slowing down.While growth is slowing down, margins are improving and the major geopolitical shifts we see around the world might ...

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Pandaxiong
·2023-11-29
Each has its own conclusion.. my thoughts is that this stock is for mid to long term investment.. like it or not, AI tech is here to stay and is continually evolving.
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liucheen
·2023-11-29
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(NYSE: PLTR) is clearly a company I was bearish about in the last few quarters while analysts seemed rather bullish about the business. In my last article, I was asking if Palantir is a Buy, Sell or Hold and came to the following conclusion (the stock was trading around $15 back then):While one could make the case for Palantir being fairly valued at this point, it is just not a bet I am willing to make. Betting on growth rates close to 30% for the next ten years to achieve a return on investment of 10% is just not my style of investing.And although Palantir is improving its business and seems to have managed to become a profitable business (at least it has reported four consistent quarters of positive earnings), I still remain rather cautious. Not only is Palantir still trading for extremely high multiples (we will get to this), but growth is also slowing down over the last few years, which is not a good sign.And I respect Alex Karp for his commitment and conviction presented during the last earnings call, but he might be a bit too optimistic:AIP and U.S. commercial, not only is disrupting the market, it's setting a standard that I don't believe any other software company will be able to reach partly because they misunderstood the value of LLMs and their relative importance and lack of importance, partly because they don't have decades of experience on the frontline as we do in the military with managing the core ways in which you make these things precise, the way in which you provide governance.Let’s look at Palantir once again and try to find out if we should invest in the great business Karp is describing.ResultsWe start by looking at the third quarter results, Palantir reported recently. Revenue increased from $477.9 million in Q3/22 to $558.2 million in Q3/23 – resulting in 16.8% year-over-year growth.Q3/23 Letter to shareholdersAnd instead of a loss of operations of $62.2 million in the same quarter last year, the company reported $40.0 million in income from operations this quarter. Not only operating income turned positive, the bottom line did the same: Instead of a loss per share of $0.06 in the same quarter last year, Palantir reported $0.03 in diluted net earnings per share this quarter. By the way, this is the fourth consecutive quarter of Palantir being profitable.Q3/23 Letter to shareholdersThe company also reported $140.8 million in adjusted free cash flow. Compared to $36.6 million in the same quarter last year, this is an increase of 285% year-over-year.Q3/23 Investor PresentationAnd finally, Palantir raised its full-year guidance for fiscal 2023 again and is now expecting revenue to be between $2,216 million and $2,220 million. In the fourth quarter, revenue should be around $600 million. Additionally, management is expecting adjusted income from operations to be between $184 million and $188 million.Q3/23 Investor PresentationGrowth Slowing Down?At first look, it seems like growth for Palantir is slowing down constantly. When looking at the last twelve-month-trailing numbers for revenue and revenue growth, we clearly see growth slowing down. In Q1/21, revenue growth was still 48.61% and since then numbers constantly got lower from quarter to quarter to “only” 16.13% in Q3/23.In a past article, I mentioned the target of 30% growth until 2025 which was one of the targets and ambitions for Palantir. In this context we also must point out that Palantir became profitable sooner than expected. In 2021, Alex Karp once stated that Palantir is planning to be profitable in 2025 – now Palantir already achieved that goal in 2023 – two years earlier. And that is the positive news when looking at the bigger picture. Gross margin as well as operating margin are constantly improving. And while gross margin is already 80%, room for further improvements is getting more and more limited – only a handful of companies is able to report margins of 85% or close to 90%. But we can assume that Palantir will be able to constantly improve its operating margin in the years to come.Author's workDuring the earnings call, management pointed out several times that growth is re-accelerating again – and that is actually true as the topline grew 16.8% in Q3/23 compared to 12.8% in Q2/23. And especially the commercial business accelerated growth. In the United States, revenue from the commercial business grew 33% year-over-year. The U.S. commercial customer account rose 12% quarter-over-quarter and is now ten-fold what it was three years ago.Q3/23 Investor PresentationAnd total commercial customer accounts increased 45% year-over-year to 330. Palantir is ascribing the growth mostly to AIP as Palantir almost tripled the number of AIP users during the last quarter and nearly 300 organization are using it since the launch about five months ago.While the U.S. commercial business is growing with a high pace, the international commercial business increased “only” 15% year-over-year with growth stemming from Asia and the Middle East and Europe being a challenge for Palantir. Overall, commercial revenue grew 23% year-over-year and reached a $1 billion annualized run rate this quarter.Palantir is expecting the impact of AIP on its customers to intensify. And management is providing several examples of companies using AIP – for dynamic scheduling of healthcare corporations to produce more efficiently and scale the workforce or identify available materials across different plants.Management was also talking a lot about the bootcamps and why they are a great success. Palantir seems to be shifting more and more on one-to-five-day long customer boot camps where commercial companies exit with a scalable use case on their actual data. The company is now running more boot camps per month than it had U.S. commercial pilots all last year.Q3/23 Investor PresentationThe World is ChangingDuring the last earnings call, Alex Karp made a strong statement where he and Palantir are standing:Palantir only supplies its products to Western allies. We've never supplied our products to enemies. We proudly support the U.S. government. I am proud that we are supporting Israel in every way we can. And we also support plain English speaking. So when people are massacred to the equivalent of almost 50,000 people in Israel, we view it as a terror act. We call it terrorism. We supply our product to people who're fighting terrorism, and we have no problem with describing as it is or sticking up for our allies and we don't provide false context.It goes without saying that the conflicts emerging around the world and turning into hot wars with thousands of people dying are horrible and any human being should be repelled by what’s happening in Ukraine and Israel/Gaza. Nevertheless, we can’t ignore reality and – as Ray Dalio recently pointed out – we are likely moving more and more towards international war:However, it is very likely the case that the images of civilian casualties we are seeing now and will see during an escalating war in Gaza will lead to new conflicts both between countries and within countries (e.g., repulsive violence against Jewish and Muslim populations in many countries). In my opinion, this war has a high risk of leading to several other conflicts of different types in a number of places, and it is likely to have harmful effects that will extend beyond those in Israel and Gaza. Primarily for those reasons, it appears to me that the odds of transitioning from the contained conflicts to a more uncontained hot world war that includes the major powers have risen from about 35% to about 50% over the last two years since I wrote my book Principles for Dealing with the Changing World Order.And Alex Karp pointed out that Palantir was always a company built for an irrational world:And then on the mission side, we have been saying and building products for a world that is violent, disjointed, irrational, a world in which you have to show strength, a world in which, if you do not show strength, people who are biased, xenophobic, dare I say any somatic will rear their head. A world in which you really have to pick sides. Palantir is the first major company to in my view to have said from the beginning, I think that is obviously true. There is no such thing anymore of being on all sides.And it seems like Palantir is well positioned for an irrational world – that seems to get more irrational from year to year. This is actually a rather bullish argument for Palantir as revenue generated in the next few years could increase as the world seems to get more chaotic and complex and governments (and companies) are searching for help and guidance to navigate in such a complicated world.Despite these reasons for higher revenue, the results from the government segment are not as great as the commercial segment results. Revenue for the segment grew 12% year-over-year and especially international government revenue increased 21% year-over-year while growth for the United States lagged. But management is optimistic here: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.Dilution vs. RepurchasesOne of the aspects I have often criticized in the past – and still see as a big problem – is the dilution of shares. In the third quarter of fiscal 2023, Palantir had 2,325.6 million diluted shares outstanding. Compared to 2,073.3 million diluted shares outstanding in the same quarter last year this is a 12.2% year-over-year increase. Management commented on the issue during the last earnings call:While we continue to manage our stock-based compensation expense, as I mentioned in previous quarters, we expect it to trend up in Q4 as we continue to invest in AIP.However, I don’t really see how Palantir is trying to manage the stock-based compensation. I still think Palantir is diluting at an extremely high pace.Data by YChartsPalantir also announced a share buyback program in August 2023 – its first ever – but according to the 10-Q statements, the company did not buy back any shares so far. And I probably agree with management not spending any cash on share buybacks right now as I still think the stock is overvalued (we will get to this) but the ongoing dilutions remains a huge problem – even when Palantir has a share buyback program in theory. And $1 billion is just enough to repurchase about 2.3% of outstanding shares. With Palantir diluting its shares more than 12% in the last twelve months this would barely have an impact – even if the share repurchase program would be executed. And as the company is pointing out – the share repurchase program does not obligate the company to repurchase any shares.Good Capital AllocationAnd while I see the stock-based compensation and resulting dilution as a big problem, I think it was a good decision from management to use the huge amounts of cash on the balance sheet to purchase marketable securities – mostly U.S. treasury bonds (according to the last 10-Q). I could not find out what type of U.S. treasuries these are but as they are listed as current assets, I would assume we are talking about bonds with a duration less than 12 months. If I am right, the company can generate high levels of interest income right now (and maybe in the coming quarters) but with short-term bonds these interest rates are obviously not fixed long-term, and interest rates could change rather quickly.Palantir Q3/23 Earnings ReleaseWe should also point out that a huge part of the company’s net income in the last few quarters is stemming from net interest Palantir generated. Interest income was $36,864 million in Q3/23 (compared to $5,540 million one year earlier). In the first nine months of fiscal 2023 the company generated $88,027 million in interest income. This is accounting for 75.6% of the net income the company generated in the first nine months. I am not saying this is a bad thing, I just think we should be aware that the business is generating a huge part of its bottom line not from its core, operational business and considering interest rates can change, the bottom line might also be different again.Intrinsic Value CalculationA final aspect we should look at is the valuation of Palantir. And here we come back to another problem and an aspect I mentioned quite often. The stock is too expensive in my opinion – and not only since it increased 250% compared to the 52-week low.When talking about valuation and the intrinsic value we can look at the two major simple valuation metrics: Not only can we calculate a P/FCF ratio, we can also calculate a P/E ratio now with Palantir being profitable for four quarters in a row. However, with Palantir trading for 342 times earnings at this point, the P/E ratio isn’t telling us much – aside from Palantir being extremely expensive.Data by YChartsInstead, we can look at the price-free-cash-flow ratio, which is providing us more reasonable numbers and metrics we can work with. For the P/FCF ratio we also have data for about three years. Right now, the stock is trading for 96 times free cash flow and therefore the stock is clearly trading below the average P/FCF ratio of 172. Nevertheless, an almost triple digit valuation multiple is also screaming “bubble”.Additionally, let’s use a discount cash flow calculation to determine an intrinsic value for Palantir. And I will not determine an intrinsic value for Palantir – as it seems difficult to make precise predictions for free cash flow in the years to come. Instead, I will take the opposite direction and make the argument why I think the current stock price can’t be justified.In order to be fairly valued right now, Palantir has to grow its free cash flow of $501.5 million (trailing twelve-month number) between 25% and 26% annually for the next ten years followed by 6% growth till perpetuity. I am calculating with 2,326 million outstanding shares and – as always – a 10% discount rate. Now let’s look at these assumptions in more detail:We can argue that Palantir – as a rather young company – might be able to grow with a higher pace than 6% in ten years from now and maybe even in 20 years from now. Nevertheless, I don’t ever calculate with higher growth rates till perpetuity as we never know what will happen in one, two or three decades from now and 6% is already optimistic (it is more or less the long-term EPS growth rate of companies listed in the S&P 500).Second, when assuming a growth rate of 25% we must take into account the dilution that happened in the past. In the last two years, the number of diluted outstanding shares was increased almost 9% annually and therefore Palantir must grow net income about 34% to set off dilution. And I assume Palantir will be able to slow down dilution, but we don’t know so far and recently dilution accelerated a bit.Third, we can look at the free cash flow Palantir was reporting in the last four quarters. And one might make the argument that free cash flow compared to revenue might be higher in the years to come (higher free cash flow margin). However, Palantir is already able to pass 24% of revenue down to free cash flow and while there are companies reporting even higher margins, this is already a very high margin.Summing up, I just can’t image Palantir can grow enough in the years to come to justify the current share price. As the FCF margin is already rather high, growth mostly has to come from top line growth and despite Palantir being innovative I don’t think growth rates between 20% and 30% (depending on the dilution) are possible in the next ten years.Bottom LineSentiment plays a huge role in investing – especially in the short term. And sentiment is influenced by storytelling and therefore a good CEO (especially in the early years of a business) also must be a good storyteller and sell a vision to investors. And I might be wrong about Palantir and underestimate the potential, but in my opinion, we can find better investments.When looking at the last few articles published on Seeking Alpha we see a mixed picture – analysts are divided between being extremely bullish and being bearish. While some see Palantir as an investment deal of the decade, other have a similar opinion as myself: the stock is overvalued.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[{"id":246646910267392,"gmtCreate":1701237820203,"gmtModify":1701237824797,"author":{"id":"4109400629381020","authorId":"4109400629381020","name":"Pandaxiong","avatar":"https://community-static.tradeup.com/news/1da1e454ba4e9ddbb7b7150abe8c6fff","vip":1,"crmLevel":6,"crmLevelSwitch":0,"authorIdStr":"4109400629381020","idStr":"4109400629381020"},"htmlText":"Each has its own conclusion.. my thoughts is that this stock is for mid to long term investment.. like it or not, AI tech is here to stay and is continually evolving.","listText":"Each has its own conclusion.. my thoughts is that this stock is for mid to long term investment.. like it or not, AI tech is here to stay and is continually evolving.","text":"Each has its own conclusion.. my thoughts is that this stock is for mid to long term investment.. like it or not, AI tech is here to stay and is continually evolving.","images":[],"top":1,"highlighted":1,"essential":1,"paper":1,"likeSize":1,"commentSize":0,"repostSize":0,"link":"https://ttm.financial/post/246646910267392","repostId":2387812911,"repostType":2,"isVote":1,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"tweetType":1,"langContent":"EN"},{"id":246646232227976,"gmtCreate":1701237780322,"gmtModify":1701237784337,"author":{"id":"3572057760878603","authorId":"3572057760878603","name":"liucheen","avatar":"https://static.tigerbbs.com/0f0fdfe7497ae7afd142c5f221ddd510","vip":1,"crmLevel":2,"crmLevelSwitch":0,"authorIdStr":"3572057760878603","idStr":"3572057760878603"},"htmlText":"🚀","listText":"🚀","text":"🚀","images":[],"top":1,"highlighted":1,"essential":1,"paper":1,"likeSize":0,"commentSize":0,"repostSize":0,"link":"https://ttm.financial/post/246646232227976","repostId":2387812911,"repostType":2,"isVote":1,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"tweetType":1,"langContent":"EN"}],"hasMoreComments":true,"newsSizeData":{"likeSize":15,"commentSize":2,"repostSize":2,"favoriteSize":1,"likeStatus":false,"favoriteStatus":false}}