Palantir: Moving In The Right Direction, But Shares Overshot Their Fair Value (NYSE:PLTR)

Investment Thesis

I wanted to take a look at Palantir’s (NYSE:PLTR) financials and its potential to be a long-term investment and whether it is a good time to invest right now after it popped 170% YTD. In short, the boat for a conservative investor has passed as right now, the risk/reward is not enticing at all. The company’s flagship new product has a lot of potential to acquire a lot more customers, which puts the company in a great position going forward. I would like to see higher EPS growth than what I modeled for the company to be an attractive investment at this point, therefore, I assign a hold rating.

Outlook

Artificial intelligence Platform- the driver of customer growth

The boom of AI is a game changer for many industries. Palantir’s expertise in so many different industries may be a good and a bad thing. A good thing is that the total addressable market is huge, but a bad thing may be that the company is not a master in all of the industries it serves right now. Other companies that solely focus on a certain market may have a competitive advantage there and would know what the customers need in more depth. With further developments, I believe that PLTR will be able to excel in many industries due to its sophisticated AI Platform. AI is becoming somewhat of a commodity, with many different players offering their LLMs, so a customer can choose whatever its needs are, and I believe that PLTR’s AIP is going to serve a very particular role that other companies’ products may not be able to cater for in the future, which will drive customer growth further.

Palantir is going hard on its next big thing- the AIP. The product has garnered a lot of attention from existing and new customers alike. PLTR has been working on this project for a long time and I believe it has a product that is going to keep the company’s revenue growth at a high level for many years to come due to how well it is being integrated into its main platforms, the Foundry, Gotham, and Apollo. In the latest earnings call, Alex Karp was asked what he thinks of the reception that AIP received from customers and he said that he was very surprised at how the US companies have started to take competition more seriously and that the way to distinguish and outplay your competition is through the use of powerful AI tool, like AIP (paraphrasing).

There is also a huge opportunity for the company to attract more customer growth when AIP is going to be offered as a separate package to clients, that is, clients that do not necessarily want to use the Foundry, Gotham, or Apollo. As Shyam Sankar, PLTR’s CTO, mentioned in the same earnings call:

I think the real focus on the AIP product strategy is to make sure that you can use AIP without Gotham, Foundry, or Apollo. And that to the extent you see the value in these things, you’re going to pull them along with you. Now, I think that’s where ontology has been most useful in both contexts.

This opens up the company’s possibilities massively and drops the restrictions on using the company’s other platforms that integrate with the AIP. I wouldn’t be surprised if after using the product, many customers might opt to integrate their systems within the Foundry as AIP could work better with it, which means extra revenues for PLTR. Selling AIP as a separate package will be the biggest driver of customer growth and growing the customer base quickly is the only reason, I would find the company a decent investment (if the share price is right). The company has grown its customer base quite rapidly over the years since its IPO and I would expect it to reach around 500 by the end of FY23 (my estimates), which will be helped by the new flagship offering.

Financials

I admit the company’s historical performance has not been the best, however, its IPO was rather recent, and its most recent situation is much more favorable. Let’s look at the company’s liquidity.

As of Q2 ’23, the company had over $3.1B in cash and marketable securities against zero long-term debt. This is a great position for the company to be in. The huge cash position and no burden of interest expense on debt allow for flexibility in its operations and support further growth of the company greatly. The management could take more risks with the cash available to them, to innovate further, or to improve their current offerings so that customers can get more value out of their offerings, which in the end will benefit everyone.

Not surprisingly, the company’s current ratio is outstanding. I would like the company to be a little bit more aggressive with its cash position, as I believe the company may be missing a lot of growth potential if the cash pile continues to grow and is not used efficiently. I’d like to see the ratio coming down to around 2. As of Q2 ’23, PLTR’s current ratio stood at a little over 5, so there has not been much change since the end of FY22. Clearly, the company has no liquidity or solvency issues.

Looking at efficiency and profitability metrics, PLTR is exhibiting signs of a turnaround story with ROE, ROA, and ROTC metrics improving quite dramatically from previous years, and it looks like these will turn positive very soon if the company can continue to operate positively under the GAAP measures, which it has for the last 3 quarters running. This tells me that the company is finally becoming a profitable business that should be creating value for investors, especially for the ones that are looking for GAAP-positive companies as these are less speculative. It is also very good to hear that Alex Karp is looking to continue this streak going forward as he would like to see the company being included in the S&P500 index in the very near future. One of the requirements the company was missing was GAAP profitability, as the company needed to report positive earnings for the last 4 quarters.

What I can see from Q4 ‘22, is that stock-based compensation played a big role in the company becoming GAAP-positive for the first time. Comparing y/y difference in SBC is around $36m from Q4 ’21 to Q4 ’22 while net income was around $31m. So, I can see the company will continue to be GAAP positive going forward because SBC is coming down dramatically over time and that is one of the biggest investor gripes with the company.

Valuation

For revenue growth, I can see the company being able to grow at a quite high caliber. The company expects to earn more than $2.2B for the year, which translates to around 16% growth. In the last 5 years or so, PLTR managed to grow at around 34% CAGR, so for the years after FY23, for the base case, I went with around 23% CAGR, which I think is still slightly on the optimistic side, however not out of the realm of possibility.

For the optimistic case, I went with around 26% CAGR, while for the conservative case, I went with around 20% CAGR. All three scenarios seem to be on the optimistic end, however, the company is still very young, and I believe the products it offers, like the AIP, will attract a lot of customers, commercial and governmental.

For EPS, I decided to adjust margins going forward so that SBC is gone because SBC is coming down considerably over the next while and I believe it’ll be a very small percentage of expenses in the future, unlike when the company went public the first year. My margins that determine EPS are as below.

For the DCF model, I went with a 12% discount rate. I decided to increase it because the company’s share price loves volatility, so I’ll need an extra margin of safety there. I also decided to use a 2.5% terminal growth rate, as that is the target inflation rate, and I would like to see the company matching that in the long run. On top of these estimates, I decided to add another 15% margin of safety to be even more cautious because the growth estimates are on the optimistic end in my opinion. With that said, Palantir’s intrinsic value is around $10.7 a share, implying the company is trading at a considerable premium to its fair value.

Closing Comments

So, even though I can see the company performing quite well and has dug itself out of the hole it has been in for many years, it is not enticing to start a position right now in my opinion. Right before the big pop in May of this year would have been ideal to hold, as the company has been trading in single digits for many months. I may have missed the boat on this stock, however, if the company can improve its numbers even more than I assumed, I will reassess the situation and update my model, but right now, with the numbers, the company is too expensive and not worth the risk.

At this point, it would be more of a speculative, momentum play, and it may work out, but the contrary could happen too, and the company falls back down to single digits in no time. The company is due to report Q3 earnings at the beginning of November, and I will be tuning in to see what kind of progress the AIP made in terms of converting more customers and what plans the management has for it.

I do believe the company will remain GAAP-positive going forward, but I would like to see these numbers improve much more before the company is worth the $17 a share that it is trading at currently. I’ve set a price alert at around $11 a share and will follow what happens with the company in the next couple of months.