We are raising our fair value estimate for narrow-moat Palantir (PLTR) to $19 from $16 after the firm reported blockbuster second-quarter financial results and raised its topline and profitability guidance for fiscal 2024.
Key Morningstar Metrics for Palantir
• Fair Value Estimate: $19
• Morningstar Rating: 2 stars
• Economic Moat: Narrow
• Morningstar Uncertainty Rating: Very High
What We Thought of Palantir’s Earnings
In retrospect, some of our prior estimates, while being above consensus, did not fully capture the AI momentum uplifting Palantir’s commercial sales. We continue to be optimistic about the firm’s AI opportunity as a deeply embedded player in the space with years of experience working with large commercial and government clients. We also think the firm’s rising profitability is a testament to the attractive unit economics built into its software business, with revenue growth far outpacing the increase in operating expenses.
From a valuation standpoint, while our forward-looking estimates testify to our optimism on the name, we remain sceptical of the exuberant valuation at which Palantir is trading. Even without factoring in the sharp rise in the firm’s stock price after hours, Palantir remains the most expensive software company in our coverage, with an enterprise value/sales multiple of around 20 times. We’d caution investors that, with the sky-high expectations baked into the firm’s current valuation, any small bump on the road can crater the stock price.
Palantir’s second-quarter sales clocked in at $678 million, up 27% year on year and more than $27 million ahead of our $651 million prior estimate. The firm’s success in the US commercial market continues to impress us, with sales from this segment expanding 55% year over year to $159 million and with US commercial customer count expanding to 295, up from 161 a year ago. Alongside commercial customer strength, Palantir’s government sales growth was no slouch either, expanding 23% year over year to $371 million. Over the long term, we expect Palantir to materially benefit from governments and businesses alike expanding their use of AI across their organisations.
Palantir’s AI Boot Camps Impress
On a forward-looking basis, Palantir’s business appears strong. The firm’s billings and RPO, or remaining performance obligations, expanded 19% and 42% year over year, respectively. We see strength in these forward-looking metrics as evidence of the strong underlying demand for Palantir’s solutions. With new customers signing up with Palantir at a breakneck rate, we see them sticking around for a long time due to the strong customer switching costs built into Palantir’s platforms.
As interest in AI has picked up over the past few quarters, companies have been scrambling to find new use cases for leveraging AI within their organisations. Palantir, rather shrewdly, saw this as an opportunity to showcase its existing AI capabilities to both commercial and government clients. The firm’s boot camps, which are essentially multiday events that help prospective customers see what they can practically achieve with its Artificial Intelligence Platform, or AIP, have been a great tool in its arsenal. Instead of investing heavily in sales, which other than costly is also time-inefficient as sales reps typically need time to ramp, the firm’s bootcamps serve as the tip of its go-to-market spear.
While we were initially sceptical of how successful a boot-camp-led sales motion could be, we’d be remiss not to note that the firm landed 96 deals with a total contract value, or TCV, of more than $1 million in the second quarter. While it is unlikely that all of these deals stemmed from the firm’s boot camp channel, we were impressed by the illustrative examples provided by Palantir of customers that signed large deals with the firm within weeks of attending a boot camp.
The firm’s boot-camp-led sales model also helped it keep a lid on operating expenses, thereby materially improving its profitability as compared with a year ago. Palantir’s adjusted operating margins came in at 37% for the second quarter, up from 25% a year ago. As we layer the firm’s success with its boot-camp-led sales model on top of the attractive unit economics it can generate from existing customers, we see further margin expansion for Palantir in the long run as the firm scales up.
Palantir’s success in AIP is not restricted to new customers. The firm’s net retention, a measure of a company’s ability to upsell existing customers, is also trending in the right direction. Net retention for the second quarter was 114%, up from 110% a year ago and 111% last quarter.
The Bull Case for Palantir Stock
For investors interested in what assumptions one must make to arrive within striking distance of Palantir’s current valuation, we also looked at a hypothetical bull case in which commercial sales continue to accelerate in the near term as the firm’s AIP attracts massive amounts of business from existing and new customers. In this scenario, we model a 26% five-year CAGR, versus our base-case five-year top-line CAGR of 22%. Along with higher-for-longer top-line growth, we also model in even more robust long-term margin expansion for Palantir in this scenario. All in all, our bull case results in a $26 fair value estimate, just slightly below the firm’s after-hours stock price.
The cherry on top of a great earnings result was Palantir raising its outlook for the remainder of fiscal 2024. The firm’s updated guidance calls for 2024 sales and adjusted operating income of $2.75 billion and $970 million, both at the midpoint of guidance, up from $2.68 billion and $874 million previously. With strong demand tailwinds behind the business’ back, especially on the US commercial side, we expect Palantir to surpass these revised estimates and are modeling 2024 sales and adjusted operating income in excess of the firm’s guidance.
