Palantir Stock: Peak of Absurdity (NYSE: PLTR)
Palantir (NYSE: PLTR) announced a set of weak results for the second quarter about two weeks ago. Its net losses persisted and revenue growth slowed. But in a seemingly crude overreaction to its quarterly results, the the stock plunged nearly 25% in subsequent trading sessions. In this article, I’ll highlight some of the key bright spots in Palantir’s Q2 results that no one seems to be talking about and try to explain why the stock is a good buying opportunity at current levels. Let’s take a closer look to better understand all of this.
Profitability of green shoots
One of the key things that sparked panic selling among Palantir shareholders was its negative bottom line. The company reported a net loss of $179.3 million in the quarter, or $0.09 per share, which left investors worried about the company’s break-even point, especially in times of macro turmoil. . Palantir has been operating as a business for over 18 years now and shareholders are losing faith in management’s ability to generate profits. If I understand the shareholder’s frustration, the fact is that on the ground, the reality is not so bad.
See, Palantir’s net loss of $179.3 million was mainly driven by non-recurring “other expenses”.
Other income (expense), net, changed $137.9 million for the three months ended June 30, 2022 compared to the same period in 2021, primarily due to unrealized and realized losses, net of our investments in negotiable securities.
The company had invested in several early stage growth companies such as Celularity (CELU), Faraday Future (FFIE) and many other names. But because the shares of these companies have rapidly lost value in recent months, Palantir has recorded those losses under its “other expenses” heading. These other expenses were nearly 3 times the company’s actual operating losses, they inflated its overall net loss figure and, more importantly, these expenses are non-recurring in nature.
An interesting picture emerges when we focus on Palantir’s operating profitability. Granted, the company had operating losses of $41.7 million, but that loss was down $146.1 million year-over-year. On a per share basis, Palantir’s second-quarter operating loss was $0.02 per share, down from $0.08 a year ago. This improvement shows that Palantir is making tangible and meaningful progress on the road to profitability.
Additionally, Palantir held only $99.2 million in marketable securities at the end of the last quarter. This means that the worst is almost over for the company and its path to profitability is becoming clearer. Therefore, I expect Palantir to become profitable on an operating level in FY23 and on a net basis in FY24/25. The company is debt-free, and it held about $2.36 billion in cash and cash equivalents last quarter, which is enough to comfortably fund its operations (and growth initiatives) in these recessionary times.
Second, Palantir’s year-over-year revenue growth for the second quarter was nearly 26%. While this is a healthy pace of growth on a stand-alone basis, it is significantly lower than management’s previous growth forecast of 30%. This slowdown in growth has fueled speculation of all kinds. While some bears believe the company has lost its appeal to customers and is succumbing to competitive pressures, others believe Palantir has reached a saturation point and faces scalability issues.
While these are legitimate concerns, I don’t necessarily share the same conclusion. The chart below highlights Palantir’s revenue across different geographies. Note how Palantir’s international segment performed poorly and dragged the company’s overall growth down. But the interesting tidbit here is that Palantir’s US revenue growth actually accelerated in the quarter.
This is rather counter-intuitive given that the Fed has been aggressively raising interest rates and companies have had to cut discretionary spending. Although European and Asian economies have also raised interest rates, their rate hike pace has not been as aggressive. On the contrary, I would have expected Palantir’s growth momentum to slow in the US before international markets. But that was clearly not the case.
That said, if Palantir was truly losing market share to its peers and/or being stalled by customer onboarding, its sales growth should have slowed in all geographic markets. On the contrary, the acceleration of its sales growth in the United States suggests that the company continues to develop well and that its platforms remain a value proposition for its customers.
Therefore, I argue that Palantir’s moderating revenue growth is a persistent seasonal factor broadly in international markets.
Next, the bears argue that Palantir shares are grossly overvalued and overdue for a correction. After all, its shares are trading at almost 63 times its free cash flow over the last twelve months, which seems quite high on the face of it. But let’s look at the chart below to get a better idea of its valuation.
The horizontal axis highlights the multiple of the price to free cash flow (or P/FCF) ratio for 130 stocks classified in the software infrastructure industry. Note how Palantir is positioned horizontally slightly to the right, indicating that it is trading at a modest premium to a wide range of its peers.
Now let’s move on to the Y axis, which represents free cash flow growth for the same set of businesses. Note how Palantir is positioned much higher vertically than most of its peers, indicating that its free cash flow growth rate is one of the highest in its industry.
The takeaway from the two axes, combined here, is that Palantir’s relatively higher valuation is justified by its high growth rate. Essentially, investors are paying a premium to own this rapidly growing company. There are only two other stocks that are growing faster than Palantir but trading at a lower P/FCF multiple.
There’s no denying that Palantir is trading at a premium to its peers, and its moderating growth has resulted in its selling. But I see this as a temporary setback. The stock is attractively priced in its sector after its recent price correction, green shoots are emerging with respect to its profitability, and its pace of revenue growth is robust in the US market at least. Thus, investors with a multi-year time horizon may consider accumulating Palantir shares on possible price corrections. Good luck!