Palantir: It Is Time

Sep. 12, 2022 9:20 AM ETPalantir Technologies Inc. (PLTR)21 Comments

Summary

  • The company is operating in big data, which is a new and important commodity.
  • Traders win over and over here.
  • Outlook is gloomy and we are seeing slowdowns in government spending, and with a recession, we could see commercial spending slow heavily.
  • Most of the negative is priced in, and you can trade at these levels, with a volatile two weeks ahead with inflation reports and FOMC meetings.
  • The balance sheet is attractive.
  • Looking for more investing ideas like this one? Get them exclusively at BAD BEAT Investing. Learn More »

Business on Wall Street in Manhattan

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Palantir Technologies Inc. (NYSE:NYSE:PLTR) stock has been an utter disaster for investors. But in contrast, it has been and continues to be one of the best trading stocks you can ask for, long and short. One great income strategy is by selling options premium (i.e., puts and calls). But investors with a buy and hold approach have been crushed so far. As a company we believe its technology is an innovative gamechanger for government and businesses. However, the growth pace appears to be slowing, management has been questioned for its decisions, and as a little to no earnings tech company, the strong dollar and higher rates have led to prolonged periods of selling. But we last said we would be buyers at and under the $8 mark. It is time.

Market still shaky

Despite markets stabilizing this past week, it has been a rough month, and of course a horrible 2022 for tech stocks that make little to no earnings. Unfortunately, despite a market rally, this remains a trader's market right now, and we think that is the best way to handle Palantir for now. The stock is still near all time lows. Investors, it may take a long time to recoup losses, but you can hold a small core position for the long-term.

That said, we think in this shaky market getting in and out is the best way to play this name. We are now having a long bias here, but with all of the issues facing the company from dilution to a questionable management team, the last thing shareholders needed was a slow down in business. And unfortunately, with the moves by the Fed to stabilize inflation, they are telegraphing their moves and letting us know growth will slow overall. In turn, pressure will be applied on business and governments. The latter is a real risk, and has led to downgrades.

Governments are spending less on investment, and it now seems that businesses are tightening up. It is interesting because Palantir's technology should help institutions save money. Why? There is real money saving potential of decision making algorithms. However in lean times we often see capex get cut, including on new technologies. This is a near-term issue, while things like dilution, and contracts signed, are longer-term.

Investors have been crushed as the stock has just fizzled out. This is not only company specific, many stocks like this are down some 70-80%. Horrible action. But, there is some justification not just on valuation, but, the Street is now pricing in the fact that Palantir may lose money or breakeven for years. Palantir was incredibly attractive with the massive growth in revenue, but now that pace of growth is slowing, and that is a huge risk. If you believe in the tech and are an investor, you can add here a small position to a well-rounded portfolio, or average down some to improve your cost basis.

The bottom line here for investors is that returns will be had if management can deliver on growing the business profitably without diluting shareholders into losses. However, it may take years to get a return. We still see it as an easier move to make shorter-term trades over and over, scalping gains. A covered call strategy at these low levels can also net some income while you wait. Operationally, the stock is coming into a range where the risk-reward is compelling at $7-$8 per share.

Operations growing, but slowing

The most recent quarter was tough, and could mark the start toward a bottom in the performance, especially if the Fed manages a soft landing. If real recession is felt into Q4 and early 2023, the market, being forward looking, may start to bid the stock higher in coming weeks. We think you can buy here in anticipation, even though overall performance was pretty mixed on the top and bottom lines in Q2. One positive was that revenue beat consensus estimates, and but the EPS figure was a solid miss.

Again, we are still in growth mode here, but the pace is slower. Total revenue grew 25.9% year-over-year to $473.0 million, beating estimates by just over $1 million. But those earnings missed by $0.04 per share, which really hurt because it was expected to see a profit. Some of the answers lie in the sector specific results. The commercial revenue stream continues to grow rapidly, while government results seem to be slowing.

While the top line grows, the deceleration of revenue growth is definitely a negative, so keep an eye one it. The company's customer count increased to 304, up from 169 a year ago, but sequentially customer growth seems to be slowing. Palantir added 27 net new customers in Q2 along with 19 net new commercial customers. The commercial revenue had been expanding rapidly, increasing 132% in 2021, and here in Q2, it rose 46% year-over-year. But that pace is slowing slightly. The concern is that if we hit a moderate recession, business spending will slow. That is a risk, and may explain in part why the stock has been pinned down more so than the tech market.

While commercial spending 'could' slow mightily in a recession, the government business growth already stalled. In Q2, the government segment's revenue did grow to $263 million. This was a small 9% rise quarter-over-quarter. One positive is that health care (both in government and also commercial) has become a substantial and rapidly growing business, generating approximately $153 million in revenue in the first half of 2022, up from $42 million in the first half of 2020. Decent growth.

Strong gross margin

If there was one big positive in the quarter it was that margins are very strong for the company. The earnings were tough due to operational expenses, but the gross margin is a highlight and we think it remains strong this year. Adjusted gross margin, which back out the dilutive stock-based compensation expenses, was a strong 81%. Operating margins were strong as well. The adjusted income from operations, was $108 million. This translated to a strong adjusted operating margin of 23%, and this was well ahead of what management's prior view of 20% was. As mentioned adjusted earnings per share was a loss of $0.01. Some of this was that there was a $0.05 impact driven primarily by losses on securities held.

Palantir's cash flow

We do like some cash flow coming in. Palantir generated $62 million in cash from operations, and the adjusted free cash flow was $61 million. This is a positive as this was the seventh consecutive quarter of positive free cash flow. In fact, over the last year Palantir generated $314 million in adjusted free cash flow. Overall, despite the stock being crushed, the company is not in any kind of danger of bankruptcy or anything like this, which matters. The balance sheet is healthy, the company still has a solid $2.4 billion in cash and cash equivalents and zero debt. They also have an additional liquidity source up to $950 million and it remains entirely undrawn. So the company has ample resources to expand, or weather a slow period.

Guidance was more than disappointing, but is now more than priced in

The biggest concern right now is not valuation though we feel all available data is now adequately priced in. The biggest concern is not the stock based compensation, or the Q2 earnings results. The slowdown is business is the risk. Management sees it, and so the Q3 guidance was below expectations. For the current Q3 2022, the company "expects revenue of between $474 million to $475 million" which was way below consensus of $505 million. In translation that means 2022 revenue could be 5% lower than expected. This is why the stock has been crushed. For the year management guided "revenue of $1.9 billion" vs. consensus of $1.98 billion. Adjusted income from operations should be $341 million to $343 million.

Buying some here

The company is operating in big data, which is a new and important commodity. Traders have won over and over again here and while growth will continue, and the balance sheet is solid, we have to keep an eye on the pace of customer growth and contract values. And while the company innovates, and helps its clients understand data and make decisions, as an investment this has been a tough place to be. We think the market will be volatile this week with the inflation report due along with next weeks' FOMC meeting. Could get a chance to dip into this in the low $7's. Entering there, and riding a small rally could set you up to sell covered calls for solid income. The volatility is high here and premiums are hefty. Alternatively, if we dip again, sell puts a month or two out and out of the money. If assigned, you have a good entry price, buy you can then immediately sell calls. If that is too much trading around the position, you can simply buy and wait for a 5-10% gains then exit. Stick to trading the name, or buy a few shares and come back in 10 years.

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Disclosure: I/we have a beneficial long position in the shares of PLTR either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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