Palantir: Single-Digit Prices Likely To Persist In 2023 (NYSE:PLTR)

Thesis

Potential investors may find Palantir Technologies (NYSE:PLTR) currently in an interesting position. As a high-growth stock, it responded more sensitively to the overall economic conditions and business cycles. As seen from the chart below, just about 1 year ago, the stock was trading at about $17.5 with a P/sales ratio of 20x. To put things under perspective, Google (GOOG) (GOOGL) on average trades at a 5x P/sales ratio. During 2022, PLTR’s stock prices have declined to the current $6.6 range, a decline of about 60%. And many of the sharp declines occurred at huge selling volumes too as highlighted by the yellow boxes in the chart below.

Such a large price correction deflated its bubble valuation by a large degree and there are indeed many positives to be said about PLTR. First, due to the ~60% price decline as just mentioned, the stock’s valuation is in a much more reasonable regime now. Its P/S ratio sits at 7.3x. Undoubtedly, it is still quite expensive (GOOG trades at 4.2x P/S ratio currently in contrast). But a 7.3x P/S is not in an alarming bubble anymore. Second, the business growth potential is quite robust, especially when/if the overall economic conditions improve. The government sector is an important and resilient source of revenue. And PLTR’s core business is to build and deploy software platforms that can serve as the central operating systems for its large government customers. A good and recent example involved its collaboration with Lockheed Martin (LMT) to accelerate Aegis and the Navy’s future integrated combat software system.

However, there are certainly headwinds too. In the remainder of this article, I will dive into the positives and negatives of the stock more closely. But overall, I see the stock prices keep being trapped in a single-digit trading range for multiple reasons in the near future. As such, my overall thesis is that if you are a long-term investor, you should wait for better opportunities. While if you are a swing trader, you can prepare for a trading window between $5 and $10 in the next year or so.

PLTR’s positives

As just mentioned, there are many positives to be said about PLTR as you can see from the many other SA authors who are more bullish on the stocks. Without repeating too much what they have said, let me just add a few comments that are less often discussed.

First, PLTR enjoys a capital-light business model. As an example, the following plot displays PLTR’s total depreciation and amortization (“DA”) and also its CAPEX expenditures in the past few quarters. Here I will use these to approximate its maintenance and growth CAPEX spending, respectively. Details of these concepts and their differences can be found in my earlier articles. As seen, its DA has been on average only about $12M per quarter during 2022 and CAPEX only about $5M on average. For a business that generates more than $450M in quarterly revenues, PLTR pushes the capital-light model to the extreme in my view.

Second, as a result of its extremely capital-light business model, the business’ true economic earning power, or owners’ earnings (“OE”), is actually much better than its accounting earnings (i.e., the commonly quoted EPS). And as a direct result, its PE multiple is lower than on the surface if it is calculated using its OE instead of the accounting EPS. As an example, the next chart compares PLTR’s accounting EPS, OE, and also its FCF per share (free cash flow) in recent quarters on a TTM basis.

The method I used to obtain its OE is the Greenwald method, as detailed in his book entitled Value Investing or my earlier articles. As you can see, PLTR’s OE has been also better than its accounting EPS. And the OE has become positive and remained positive since the March 2021 quarter even though its accounting EPS remains in the red. For the most recent quarter of Sept 2022, my estimate for its OE is about 6-7 cents per share on a TTM basis.

PLTR’s negatives

However, there are negatives too. As aforementioned, the government sector is an important and resilient source of revenue for PLTR. However, during periods of economic uncertainty like what we are going through now, its major government clients are nonetheless subject to a number of uncertainties. These uncertainties include budget constraints, policy changes, and also the possibility of a full-scale economic recession. The timing and scale of any new deals can be hard to determine and contract renewals are not guaranteed either. It has recognized the issues. And management is trying to diversify its revenue sources by attracting customers from the private sector. However, these initiatives are still in their early phase.

The consensus estimates seem to take note of the uncertain earning prospects. To wit, the earnings revisions for the last 3 months reflect a quite gloomy outlook. As seen, only 1 analyst submitted an upward EPS revision while a total of 7 analysts submitted downward EPS revisions. Furthermore, the downward revisions are quite substantial, in the range of 72% to 30% in the next 1 or 2 years as seen.

Second, its current PE multiples are still too high in my view. As mentioned earlier, the recent correction has brought its P/S multiple to 7.3x, still about 2x more expensive than the overall market. In terms of PE multiples, the valuation is just unsustainable in my view. Due to its negative EPS as mentioned above, its TTM PE is meaningless. And its FWD PE is 142x for FY1 and 38x for FY2. Such PEs are not only expensive on an absolute basis but also very expensive when compared to some of its peers such as TTD and GOOG.

Admittedly, as mentioned in an earlier section, its accounting ESP systematically understates its owner’s earnings. But even when we consider its PE multiple on an OE basis, its current PE is still in the range of triple digits ($6.6 share prices on 6-7 cents of OE per share TTM). Even if its prices fall to $5, the lower bound of my forecast price range, its PE on an OE basis would still be above 70x.

Other risks and final thoughts

Besides the risks analyzed above, PLTR’s financial strength is also a bit concerning. It goes without saying that its financial position is weaker than the likes of GOOG. Even when compared to smaller and less-mature players such as TTD and TYL, its financial strength is relatively weak by a good margin. As you can see from the following chart, Altman’s Z-score currently hovers around 0.45 (compare to 3.9 for TTD and 2.33 for TYL. As a rule of thumb, a Z-score around ~3 is regarded as safe and a score below ~1 is regarded as a red flag.

To conclude, I foresee its stock prices trapped in a single-digit range in the next year or so given the above uncertainties on both sides. As such, my overall impression is that the stock is mostly suitable for speculative swing investors.