The Bottom For Palantir Stock (NYSE:PLTR)

Palantir Technologies Inc. (NYSE:PLTR) stock has been a mess for longs over the last 18 months, but we are of the opinion that the bottom has been formed. The recent market rally has helped propel the stock back to nearly $10. We believe over the next month or so the stock is going to pull back with the broader market, so there will be an opportunity to buy shares again, perhaps under $8. Generally speaking we think we are in a bear market rally the last few sessions and while it is great to get some relief, we think the averages have more to the downside, at least for a retest of the lows. Palantir stock will not be immune, and you will get a chance to come back into the name again at a better price. Frankly, our team has been recommending members buy high quality, earnings positive stocks, preferably with a dividend, while at least in the short-run, little-to-no earnings stocks are extremely speculative. Stocks like Palantir have been volatile, and that has been good for day trading. But, we think on the next sizable downdraft, investors can place their bets. Palantir is operating in a 21st century commodity: data. Governments and businesses alike can use data as a weapon to get an edge over the competition. And Palantir could be considered ‘an arms dealer’ of sorts for supplying the weapons of data analysis and decision making. The technology is game-changing, but there are investor concerns, including a murky growth outlook, as well as dilution issues which can harm the ability of the company to meaningfully grow earnings in a sustainable fashion. Still, we think that this is a name to buy low and tuck away for years.

Invest as part of a well-rounded portfolio

We teach people how to trade, and spot opportunity, but also discuss how to structure portfolios particularly in times of distress. And right now, this is a distressed market. You do not completely abandon growth/innovative tech. That is wrong. In our opinion there is lucrative opportunity in select names. Palantir is one of them, on the next down draft. We think you add in a tactical manner to a position like this on market weakness, and place it in a well-rounded portfolio. Do not obsess over the day-to-day changes in the stock. Rather, follow the quarterly filings, new contracts, management commentary, and trends in big data analytics. Do not invest money you will need in the next 5 years. Sounds simple but it is amazing how many people do not have a plan in place.

Palantir’s model is strong, but there are profit woes

We absolutely love the operations here, but there are profit woes. Big data is a new commodity. What is interesting about Palantir is that it generates revenue from selling cloud-based subscriptions, as well as through the sale of subscriptions on the actual premises of customer facilities. These sales can be recurring revenue sources, and they include ongoing operations and maintenance services. It is possible that full contract values may never be realized for some reason or another. But it is key to understand that every time a new contract is signed, revenue is generally recognized over the contract term on a ratable basis. The company also offers professional services such as on-demand support, tailored platform configurations, training, and specialized forecasting. The kicker is that Palantir prices its products/services based on how much impact their data analytics can help a company, taking into account the size of the company and other factors in their pricing algorithms.

Palantir is seeing revenues grow tremendously, but the company also invests mightily in their own growth as these revenues increase dramatically. And as we know, such investment comes at the cost of profit. For years, Palantir may lose money or breakeven, while it establishes its dominance in the marketplace, and pulls in more and more of the total addressable market. Another issue to consider here is that like many innovative companies trying to attract and retain top tier talent, the company is addicted to stock based compensation. While it may seem like drops in a bucket, over time, the bucket could overflow, for lack of a better analogy. Dilution could continue so long that positive EPS becomes out of reach without future buybacks, even if overall net income widens and grows. This would keep the stock pinned. It is a risk. That said, operationally we are seeing some positive signs. Internal metrics improve year-after-year for Palantir, and for now ongoing growth will continue. This growth would likely lead to real and sustained profit growth, if not for dilution and of course investment in its own growth. The company’s profitability is questionable, but the good news is that it is not hemorrhaging cash. In fact, Palantir is breaking even and making some money some quarters.

In the just reported quarter, performance was strong on the top line and ahead of consensus estimates. Total revenue grew 31% year-over-year to $446 million, beating estimates by almost $3 million. However, its profitability was lower than expected by $0.02, and worse, guidance was less than consensus. That crushed the stock.

Now what is frustrating from an investor standpoint is that Palantir has good margins. Positive margin momentum in a software company is strong. Adjusted gross margin was 81% in Q1 while contribution margin was 57%. First quarter adjusted income from operations, excluding stock-based compensation and related employer payroll taxes was $117 million, representing an adjusted operating margin of 26%. That is solid. Both segments are doing well.

Palantir’s reporting segments both growing

One thing investors can watch for is news on newly awarded contracts, keeping in mind the revenue recognition schema employed by the company. There was a $50 million plus contract just signed with U.S. Space Systems, for example. So Palantir has commercial and government revenue, as noted previously. Make no mistake, the commercial revenue stream continues to grow at a significant pace. The government revenue growth is a bit slower, rising 16% in Q1, but as more and more governments learn the power of using data to streamline operations, funding, international relations, military decision making, and more, we expect this area to be a tremendous source of growth.

There are questions on the backlog, but the timing of new contracts comes in waves. Some months are slower, others see multiple contracts. It really depends. This adds to some uncertainty for investors, but you get the general idea. One thing that we learned in quarterly disclosures is that Palantir has expanded its sales team. The wave of new hires is working to secure new orders. The company added a total of 40 net new customers in Q1, and looks to add many more in 2022. The commercial revenue is really expanding at a strong pace, increasing 132% in year 2021, and in the first quarter was up more than 50% year-over-year. The key to remember is there will be substantial quarter-to-quarter variability.

Keep an eye on cash flow

There is a lot of mixed news to digest when considering investing here. While margins are good, profits per share stink. Further, the company lost $39 million in the quarter operationally, but adjusted income from operations was $117 million. That said, the company is still free cash flow positive. This is a very important point. You have to watch cash flows. It will fluctuate, but we want to see sustained positive cash flows, and perhaps more importantly, cash flows that grow over time. In Q1, adjusted free cash flow was $30 million for the quarter.

Forward view tough to pinpoint

The biggest concern right now is not valuation, and by most accounts, the stock is expensive at $10. Let it fall. In addition, stock-based compensation which is a risk, is not the largest risk. The broader market has been horrific, but that is still not the largest risk. Investors will get crushed if there is a meaningful slowdown in performance. While Palantir’s technology should help governments and businesses alike operate more efficiently, and therefore more profitably, we could see reduced spending on services like this in the short-term if there is a recession. Some companies “could” turn to Palantir’s solutions to save money, but we think that companies would be more than likely to shy away from big new data contracts in the short run in a recession. Furthermore, the Q2 guidance was less than stellar. We will find out in a few weeks how the company did, but management guided to a base case of $470 million in revenue. This was below consensus of $484 million. Unless something changes in the next few quarters, like a recession, Palantir continues to see 30% annual revenue growth through 2025. If costs can be kept under control, we could see profit growth potential.

Final thoughts here

The rally from the bottom has been quite strong frankly. We believe you must let the shares pull back. We give it a buy rating, but this is on the notion that shares pull back again in this bear market. We think you can get a much better price than $10 this summer. Scale into the name, so that you can have a profit on a modest bounce. The company operates with no debt and has nice positive free cash flow, and this is a key metric to watch going forward. There is a lot of promise here for future profits. The customer growth is impressive as is the revenue growth. Invest in data as a commodity. Palantir is a good choice for a small position in a well-rounded portfolio.