Palantir: Risk-reward proposition looks good after Q3 results (NYSE: PLTR)

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Palantir Technologies (NYSE: PLTR) released its third-quarter results last week and they were close to expectations. The company also provided encouraging signs regarding future operating momentum. Its shares remain undervalued and long-term investors should continue to buy.

As I covered in previous articlesI am bullish on Palantir over the long term as I consider the upside potential to be quite attractive, although in recent quarters the company’s financial performance has been poor due to macro issues that have slowed growth.

However, if the company executes its growth strategy well, it will become a much bigger company over the next few years and will likely break even operationally by 2025, as I analyzed in a recent article. While as an early growth company, Palantir’s investment case is still somewhat speculative, it is in the right direction to become a profitable mid-term company.

Palantir Profit Analysis

Last week, Palantir released its latest quarterly results and they were largely in line with expectations. Its quarterly revenue was $477.9 million, while the street expected $474.5 million and its forecast was $475 million, and its adjusted EPS was 0, $01 (vs $0.02 expected).

In Q3 2022, Palantir’s revenue grew 22% YoY, a lower growth rate than the prior quarter (+26% YoY), and also below its annual target of approximately +30 %. Despite slower growth in recent quarters, the company achieved significant milestones, namely that its government business reached $1 billion in revenue for 12 consecutive months and it was the first time ever that it reached this figure. Additionally, new business and billings continued to increase at high growth rates.

Q3

Offers and invoicing (Palant)

Moreover, while revenue growth has slowed, on the other hand, its number of customers continues to increase at a healthy pace, reaching 337 at the end of September, which represents a 66% increase year-on-year. During the quarter, the company added 33 net new customers (compared to 27 in Q2 2022), which is a positive sign that Palantir’s growth strategy is progressing well, especially with respect to its commercial push, which is the segment that has led revenue growth more recently.

Indeed, in the last quarter, Palantir’s U.S. commercial revenue increased 53% year-over-year to $88 million, while total commercial revenue accounted for approximately 43% of total revenue. This is supported by a growing number of customers, which grew to 132 in the US alone at the end of Q3 2022, up 124% year-on-year. On the other hand, US government revenue grew 23% year-on-year, a growth rate well below that of the commercial segment.

As for its net dollar retention, it was 119% last quarter and unchanged from the previous quarter, which is positive as repeat customers continue to increase their engagement with the company, bodes well for growth. future revenue as the total number of customers increases.

Additionally, in the third quarter, the total value of its remaining transactions increased 14% year-on-year to $4.1 billion, an increase of $600 million from the second quarter of 2022, which is a another positive sign of stronger revenue growth in the near future. Investors should note that Palantir reported some weakness in this metric during Q2 (up just 4% YoY to $3.5 billion), so the reported increase in Q3 shows that the Palantir’s offering continues to add value for its customers and that they are ready to enter into mid to long-term service commitments, even in the current uncertain macroeconomic environment.

In terms of Palantir’s profitability, the company continues to invest in growing its business and maintaining its hiring plans, which hurts its operating margins in the short term, but supports its long-term growth. Palantir continues to add sellers and software engineers despite a weaker macro backdrop, while other tech companies are freezing hiring or cutting staff to cut costs, like Metaplatforms (META) and Microsoft (MSFT) have done recently.

During the quarter, Palantir increased its workforce by 450 people, its largest quarterly hire during the year, which was the main driver of higher operating expenses, which increased 9% quarter-on-quarter to reach $397 million excluding stock-based compensation. As a result of this strategy, its adjusted operating income was $81 million in Q3, down from the same quarter last year, and its operating margin fell to 17% (from 30% in Q3 2021 ).

Q3

Operating result (Palant)

Its adjusted free cash flow was $37 million in the third quarter, marking the eighth consecutive quarter of positive free cash flow generation, while in the first nine months of 2022 its free cash flow adjusted was $231 million. At the end of September, Palantir’s cash position was approximately $2.4 billion and the company remains debt-free, thus having a very strong balance sheet.

As for its guidance, the company expects third-quarter revenue to be around $504 million, while the market expected $503 million, and forecasts operating profit of $78-80 million. For the full year, its annual revenue is expected to be approximately $1.9 billion, an annual growth of 23.3%.

This means that Palantir will miss its annual revenue growth target by approximately 30% as the difficult economic environment and the strong dollar impact international revenue, and US government revenue has grown at a slower rate. than expected in recent quarters.

Despite this, Palantir’s medium-term growth strategy is not downgraded, which clearly shows that management has a long-term mindset and maintains its business plan to create shareholder value on the long term, even if in the short term it has a negative impact on its operating margins and its share price.

Evaluation

In terms of its valuation, like most growth companies, Palantir’s valuation has deteriorated significantly over the past few months, even though its long-term fundamentals haven’t changed much. Although revenue growth and profitability have been weaker in recent quarters, this is justified by external pressures rather than fundamental issues. Therefore, a rebound in these measures is likely as economic conditions improve over the next few quarters.

Given this backdrop, like many growth companies that are currently unprofitable and showing some slowdown in revenue, Palantir’s stock has been punished in recent months and is down around 55% since the beginning of the year.

As the following chart shows, Palantir was valued at more than 30 times forward earnings at the end of 2021, but its valuation has fallen significantly over the past few months and is currently trading at around 6.5 times forward earnings .

Q3

Evaluation (Bloomberg)

As a result, Palantir’s devaluation has been quite rapid and is trading at a discount to its historical valuation over the past year (around 10.4x forward earnings), and also well below its historical valuation since its direct listing in 2020 (historical valuation of approximately 18.6x revenue). This means that given its recent historical valuation, Palantir’s risk-reward proposition looks good, as the downside looks limited and the upside potential is quite good.

This view is also confirmed by an absolute valuation approach, given that current consensus 2025 revenue estimates of around $4 billion and a valuation multiple of 10.4x (in line with its recent historical average ), my price target for the end of 2024 is $14 per share, which is 76% higher than its current price. However, this assessment may be far too conservative and a higher multiple is likely if growth improves over the next two years, leading to an even higher upside.

Conclusion

Palantir reported a decent third quarter and its guidance was more or less in line with market expectations, which was not enough to boost its share price, which reacted negatively on earnings day. However, more importantly for long-term investors, in my opinion, the company released good metrics on customer growth, number of transactions and billings, and increased total value of remaining transactions, all positive signs for revenue growth in the coming quarters.

Additionally, Palantir continues to invest in the growth of the business, showing that it maintains its long-term approach, which should create long-term shareholder value. Its shares remain undervalued and Palantir is a buy following its third quarter earnings report.

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