Palantir Stock: Strong Fundamentals And Attractive Valuation
Palantir (PLTR), the stock, has been under a lot of pressure due to an unfriendly market environment for growth stocks over the past year. Palantir the business, on the other hand, is delivering very solid performance and consolidating its competitive advantages while building the foundations for long-term growth. At current prices, Palantir is well-positioned for attractive returns going forward.
Palantir's Solid Performance
Palantir reported better than expected sales and expanding profit margins for Q3 of 2021. Guidance was also healthy, as management raised expectations for revenue and cash flow in the full year.
Total revenue grew 36% year-over-year to $392 million. For Q4, Palantir provided guidance for $418M in revenue, above the $401.87M expected by analysts at the time of the report. The company added 34 new customers during the quarter.
Very importantly: US commercial revenue grew 103% year-over-year, this is an acceleration versus prior quarters, and a major positive for the investment thesis, as it shows that Palantir is succeeding at expanding beyond the government sector. The main game changer for Palantir's stock in the years ahead is a successful expansion in the commercial segment, and the company is delivering very well on that front.
Palantir Revenue (Palantir)
Cash flow generation is also trending in the right direction, which is quite important in this market environment. When the market is scared about inflation and interest rates, companies that are already generating positive cash flows are considered safer and more reliable.
Palantir Cash Flows (Palantir)
The remaining deal value - which shows the trend of future revenue - is more than strong and even accelerating.
RPO (Palantir)
The big picture thesis for Palantir is quite simple. We are seeing an exponential proliferation of all kinds of data, but organizations don't understand how to make sense of this data and how to transform the data into opportunities to catch terrorists, distribute vaccines, increase car sales, or make a production process more efficient and profitable. The trend is going to remain strong and even accelerate in the years ahead due to the explosion in data generation.
Very few companies have the capabilities and the trust required to do this job. Once Palantir is entrenched into an organization, it tends to stay there and make more revenue from each customer over time by providing more and better solutions.
In the government sector, the pandemic and all the challenges related to running the healthcare system, plus distributing the vaccines, made it quite clear that data analytics is of the utmost importance. Regarding the defense sector, the recent tensions with Russia and China show that this is not the time to be saving money on AI data analytics for military purposes.
The business sector is moving in the same direction. Palantir software is expensive, but falling behind the competition in such a crucial area can be of orders of magnitude much more expensive.
Consistent innovation is a key growth engine for Palantir. The new partnership with Satellogic unlocks advanced image and geospatial products and tailored AI insights for customers. The recent launch of Foundry for crypto is another example, opening the doors to exciting possibilities in the years ahead.
Palantir's Competitive Advantage
Palantir is delivering very strong numbers across the main operational metrics, and the financial indicators related to sales, margins, and cash flows are moving in the right direction too. This is great to see, but investors need to wonder if the company has the competitive strength to sustain this performance over the long term.
The market opportunity is enormous, so that is not much of a problem. The big issue is whether Palantir has the competitive strength to continue capitalizing on this opportunity for years and even decades to come.
Here are some insightful comments from management on the issue of competitive strength during the most recent conference call:
Our competition is not any other Company. The competition is our customers, specifically, our customer's IT department and their desire to build their own solution. And you know what? It's not even really their fault.
There's an army of consultants and comp providers who pedal completely bogus DIY market textures that are never going to work. It took us 15 years and nearly $3 billion of development and we continue to innovate every day.
Just last week, we had a meeting with the Fortune 200 CIO, who was so excited to see Foundry because he has spent the last 3 years trying unsuccessfully to solve the same problems with a leading cloud provider; 3 years. And they aren't the only ones.
These are our favorite conversations because having tried and failed, the customer knows exactly how valuable it is to buy a solution that works in days at scale.
But that's not really what makes us a better choice. We're a better choice because we focus exclusively on alpha. We express their strategy. Whereas most enterprise software makes the customer more similar to the competition, our products are designed to make them more differentiated.
High switching costs and intangible assets are the leading sources of competitive advantage for Palantir. Customers build their software on top of Palantir's platform, and the company is now launching Operational APIs to strengthen this dynamic.
The API toolset allows for third parties and customer developers to programmatically interact with Foundry, making Palantir increasingly entrenched in its customers' operations.
In order to sustain its competitive advantages over the long term, Palantir needs to continue investing in R&D in order to anticipate customer needs and to remain at the forefront of technological possibilities in the industry. This is not easy to do, but the company has proven that it can execute.
PLTR Stock - Cheap Valuation
Due mostly to a terrible market for growth stocks since February of last year, Palantir is now trading at the lowest valuation levels observed since the company became public via a direct listing. The Enterprise Value to Revenue ratio used to be comfortably above 30, and now it is below 17.
Data by YCharts
Valuation is always tricky for such a unique company. Palantir is one of a kind in a sense, and there is a considerable degree of disparity regarding estimates and price targets among the analysts following the stock.
That said, the most conservative assumptions indicate that the stock is fairly valued, while more optimistic calculations indicate that Palantir is widely undervalued.
The average price target among the analysts following the stock is $20.56, implying an upside potential of roughly 157%. Even the lowest price target signals that the stock is fairly valued at $13. The most aggressive target stands at $31, which would mean a huge upside potential of 237%.
(Click on image to enlarge)
PLTR price targets (Seeking Alpha)
The fact that there is such a wide degree of dispersion among the analysts following Palantir shows that this is a very particular company, and it is not easy to reach a consensus regarding what sales and earnings will look like in the future, let alone applying a "fair" valuation multiple to those sales and earnings estimates.
This can be seen as a source of risk for investors, but uncertainty is not the same as risk. Uncertainty means that sales and earnings are hard to project, which generally makes the stock price volatile. Risk, on the other hand, is the probability of a permanent loss of capital.
Especially at these valuation levels, as long as the fundamental thesis remains intact, investors should rather focus on the big picture of long-term value creation as opposed to fixating too much on earnings for a particular quarter.
After all, the companies that are misunderstood and hard to assess can many times present the best opportunities.
The valuation ratios for Palantir are at historical lows, and the stock is priced in line with the most conservative price targets, while also offering abundant upside potential versus average estimates. Under more aggressive valuation assumptions, Palantir looks widely undervalued and positioned for massive returns. All things considered, valuation levels are more than attractive for investors in Palantir at current prices.
Risk And Reward Going Forward
Palantir is scheduled to report earnings on February 17. It doesn't make much sense to try to speculate about how the numbers will come in and how the market will react to those numbers, especially because short-term price reactions can be irrational.
Growth stocks have been excruciatingly volatile lately, and Palantir is even more volatile than other growth stocks in the market, so investors owning Palantir should not be surprised to see some fireworks after earnings. It is also important to keep in mind that the initial price reaction is not always very relevant from a long-term perspective.
An important negative in Palantir is the company's generous stock-based compensation program, which amounted to almost $185 million during the quarter ended in September.
Part of it comes with the territory. If you want to attract top talent and you want to provide the right incentives for those employees then you need to use stock-based compensation as a critical tool to achieve those targets. Nevertheless, this is a key issue to monitor going forward, as dilution via share issuance can be a major headwind for investor returns.
Palantir has long-term contracts of enormous value and the sales cycle tends to be much longer in comparison to a regular software business. This makes revenue and cash flow harder to predict in the short term, and perhaps it explains why the analysts following the stock have such a wide disparity in their estimates.
The point, however, is that many of those risks are already reflected on market expectations and hence on the stock price. Palantir is a unique business executing at a high level and trading for more than reasonable valuations. The conditions are set for attractive returns going forward.
Disclosure: I/we have a beneficial long position in the shares of PLTR either through stock ownership, options, or other derivatives.
Disclaimer: I wrote this article myself, and it expresses ...
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