Palantir: It May Get Better Before Getting Ugly

Summary

• I think Palantir's Q4 2022 results could beat market expectations regarding revenue growth.
• I reached this conclusion after analyzing the recent Q4 2022 results of Palantir's peers.
• In the longer run, Palantir may continue facing intense competition even in its government sector - bad news for consensus believers.
• When a recession comes, PLTR's strong correlation with the ARK Innovation ETF will likely drag the stock down to a more reasonable valuation level.
• Buying PLTR before the report is up to you. I'll be watching it from the sidelines if you ask me.
• Looking for a helping hand in the market? Members of Beyond the Wall Investing get exclusive ideas and guidance to navigate any climate. Learn More »

Marco Bello

Why Am I Upgrading Palantir to Neutral?

In a week, Palantir Technologies (NYSE:PLTR) will release Q4 2022 numbers [February 13, post-market], which I think could beat market expectations regarding revenue growth. With the same adjusted margin as last quarter, PLTR is also likely to beat EPS estimates. As a result, I have decided to upgrade the stock from Sell to Hold. However, this upgrade does not refute my earlier thesis that the company is quite expensive and faces intense competition in its key end markets - if recent fears of a recession come true, I think the stock will hardly be able to please its investors this year.

Q4 FY2022: Why It May Get Better?

Since October 5th, 2021, I've published 10 bearish articles on Palantir stock on Seeking Alpha. Back then, the bulls were forecasting a free cash flow margin of 40% for the next 10 years, and some were even projecting the company's sales growth 25-30 years into the future with an exit price-to-sales multiple of 2-5x. This seemed like complete nonsense to me, as multiple contraction is a typical thing for fast-growing firms - many bulls appeared to overlook or underestimate its impact on PLTR's market cap, which was worth more than 31x sales in October 2021.

Time passed and I kept updating my bearish thesis based on PLTR's a) expensive valuation, b) SBC practices that kept diluting retail investors, and c) business model that shows some signs of failure. What remains of these arguments today? Palantir stock trades at 7.6 times revenue, 29 times EBITDA, and 52 times net income [all numbers are 1-year forwarding]. And that's a lot - still. From December 31, 2021, to January 1, 2023, PLTR's average shares outstanding [on a quarterly basis] are up only 3.01%, which is not much, but the whole time management has been getting their stock bonus, they have been selling it immediately on the open market - whatever the actual reason, that fact did not help the stock weather the storm in 2022 and will not help it in 2023 - if there's another one. The third point of mine - now related to the failed business model - was also visible in the way the company reported for Q3 FY2022 and deviated from its own growth plan:

Seeking Alpha News

Now, however, I think that next week the company should report better than the market expects - at least in terms of revenue growth.

I reached this conclusion after analyzing the recent Q4 2022 results of Palantir's peers, taken from Bank of America's list as of February 2nd, 2023 [ZeroHedge's proprietary source]:

BofA, February 2nd, 2023 [author's notes]

Palantir is on the BUY list - its coverage was initiated by Mariana Perez on June 21, 2022, and since then the bank's price target has increased by $1, or ~7.7%. But that's not the most important thing I want you to pay attention to. Of the 19 names on the BUY list, 7 companies comparable to PLTR have already reported Q4 2022 numbers. And my analysis shows that even this limited sample of companies can predict Palantir's revenue growth for Q4 FY2022:

Author's calculations, based on BofA's research and Seeking Alpha data

Since Palantir went public in late September 2020, its sales were growing quarter-to-quarter [QoQ] in line with the relative dynamic of how the combined revenue of those 7 companies was growing. The brightest deviation from that correlation was seen in Q3 2022 when Palantir underperformed this particular peer group [by a margin of >2x]. Now the Street waits for PLTR's QoQ sales growth of ~5.7% - that's amid the group's actual sales growth rate of 8.12%. If the historical relation comes back to where it was before Q3 2022, I think PLTR's Q4 results should be higher in terms of revenue.

This conclusion is confirmed when we expand the sample to take into account the names included in the NEUTRAL and UNDERPERFORM lists - out of 38 names [in total], there are 14 that have already reported Q4 figures.

Author's calculations, based on BofA's research and Seeking Alpha data

Combined sales of these 14 companies grew 12.8% QoQ in Q4 FY2022 - more than double PLTR's consensus forecast. In general, the market expects Palantir to return to its Q2 2022 QoQ growth rate, while the broader sample has more than doubled that period's growth rate.

Against this backdrop, if the company manages to maintain or even improve its margin, then actual EPS numbers should automatically exceed the $0.03 per share that is priced-in today. But there are enormous fundamental risks that cannot be offset by 1 good, stronger-than-expected quarter.

Post-Earnings: Why It Can Get Uglier?

The truth is - despite the company's "unique offerings" - Palantir is unlikely to get rid of competition in its end markets. At one time - at least from what I regularly read from bullish authors - the company was unbeatable in its Government segment. Supposedly, that fact alone and the mass of underlying government contracts should be enough to justify all the hopes pinned on PLTR's "30% CAGR over the long term" despite the obvious competition in the Commercial segment.

There has been a significant amount of negativity surrounding the company at the end of January, which hasn't been seen since the publication of its Q3 FY2022 report - that's when I discovered that the company is facing increased competition in its government segment:

Socialsentiment.io [author's notes]

In late January, Peter Thiel called the British people's affection for the state-backed health service "Stockholm syndrome" - and that's amid its company vying for a £480 million ($595 million) data contract with the National Health Service.

Palantir's Foundry software was utilized during the Covid-19 crisis to monitor vaccine distribution and, more recently, manage the backlog of patients waiting for non-emergency surgeries. However, the company's partnership with the NHS has faced criticism from civil liberties organizations that claim that Palantir has an unfair advantage in securing contracts over competitors.

Just days after those words from Thiel, the Telegraph reported that C3.ai (AI), a U.S. artificial intelligence company founded by billionaire Thomas Siebel, is also competing for the same multi-million dollar contract from the NHS. Quantexa, a UK data company, has also publicly declared it will bid for a role on the NHS data project.

Old cases have surfaced in public that Palantir may have been dishonest in obtaining its contracts with the NHS, which I believe may have a negative impact on obtaining new contracts in the future. Reputational risks pose a great danger to the expansion of the company's backlog, in my view.

So far, analysts are still quite generous about the company's growth prospects - according to the consensus estimates of 13 analysts, sales will grow steadily by more than 22% [annually] over the next 2 years, while adjusted EPS will increase many times over:

Seeking Alpha, author's notes

At the same time, the company is valued at 50 times next year's net income - I have included a comparison with the valuation of the median company in the sample from the BofA list [see charts above]. In the "ALL" sample, the median company is more than 2 times cheaper than PLTR, and at the same time, the growth was much better [QoQ], at least for Q3 2022.

I think the competition in the form of C3.ai is a pretty important signal for PLTR investors that they need to watch the NHS case very closely. Under the current circumstances, I believe it will be increasingly difficult for PLTR to meet the revenue and EPS targets set by analysts - especially without adjustments for SBC and other adjustable items.

Bottom Line

Despite the many risks inherent in my conclusions today, one thing remains unchanged - the bullish sentiment that has prevailed in the market since December 2022 is not justified by the macro indicators. This is definitely true for the search for the bottom of the market - jobless claims and ISM manufacturing reports tell us that we have not arrived there yet:

Kantro [Twitter: @MichaelKantro]

The top part of the chart says that we have never reached the bottom without at least a moderate increase in unemployment. The bottom one says we need to see a sustained turnaround in construction starts and PMI. How is that related to PLTR? No matter what anyone says, this stock is still too expensive for the growth it offers - so when a recession comes, PLTR's strong correlation with the ARK Innovation ETF (ARKK) will likely drag the stock down to a more reasonable valuation level.

Data by YCharts

Therefore, I expect better-than-expected Q4 FY2022 results from the company next week - if so, they could lead to a new wave of optimism. However, it is unlikely that this optimism will turn into reality, as the longer-term consensus forecasts are still too high to be reached, in my view - especially at the dawn of future stock market difficulties.

Buying PLTR before the report is up to you. I'll be watching it from the sidelines if you ask me.

Thanks for reading!

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.