Downgrading Palantir To Hold – Too Many Positives Baked In

Summary:

• We’re downgrading Palantir to a hold based on our belief that the stock is overbought at current levels and expect a price correction.
• Palantir has a lot of positives propping up investor confidence and its stock price performance, with most excitement around its inclusion in the S&P 500 and its Warp Speed.
• The stock is comfortably the most expensive name in our software coverage and trades at a multiple of around 95 times next year’s earnings expectations.
• We believe investors are better positioned on the sidelines for the near term as the market has exhausted current positives.

We’re downgrading Palantir (NYSE:PLTR) to a hold. The stock has peaked for the near term, and now we expect the pace of outperformance to moderate over the next quarter. The stock is up 128% since our upgrade to buy in November 2023 against the S&P 500, up 32% during the same period, as shown below. A lot of positives have been priced in over the past six months, including Palantir’s inclusion in the S&P 500 and the new Warp Speed offering under their AIP, causing the stock to trade 88% higher over the past six months versus the S&P 500 up 11% during the same period. The stock is up 16% since being added to the S&P 500. Palantir is, at current levels, the most expensive company in our software coverage. We think the market has exhausted Palantir’s near-term catalysts, and we would recommend investors stay on the sidelines and trim when opportunistic for the near-term.

For a quick recap, Palantir is a leading data analytics company with heavy ties to the U.S. government founded in the aftermath of 9/11 in May 2003 to enhance the ‘war on terror’; the business is center-stage in the post-pandemic environment on its work in AI (launching its Artificial Intelligence Platform, or AIP last year) and more recently it’s gotten extra attention on the war on ‘terror’ playing out in the Middle East over the past year now. The chart below showcases Palantir’s profit re-acceleration over the past two years, supported by a new product cycle from Palantir with AIP and, more recently, Warp Speed and higher commercial revenue, as well as higher defense spend. Management expects GAAP operating income and net income quarterly this year, with adjusted free cash flow of $800M to $1,000M for the FY24.

The reason behind our downgrade is twofold.

The first part concerns the stock’s price movement. On Wednesday, Palantir’s two-day rally reached 9.7%, with another $1.21 added during the trading day before noon, bringing shares to $42.66; just one week ago, headlines read, “Palantir stock soars to 52-week high, hit $38.22.” There are a lot of bullish indicators coming out of Palantir, according to data from Refinitiv. For starters, the stock’s 200-day moving average price, or MAP, is $25.24 as of Wednesday, with a price-to-MAP ratio of 1.69, marking a bullish indicator. Another bullish indicator is the share price outpacing MAP in 63 out of the past 64 past days. There are equally important red flags as well; the relative strength index, or RSI, is at 72.1, breaking the overbought threshold at 70. This tells us that something is up with the 12.5% gain over the past two weeks, especially considering the RSI was 63.6 before that. The Williams % R indicator also flags a similar issue with a Williams % R indicator of -0.7 compared to the previous number of -30.6, meaning the price is near the 14-day-high. We think this stock price performance indicates a higher risk profile for Palantir and leads us to expect a price correction.

The second concern we have is about what has been priced in. The company has been on a streak ever since joining the S&P 500, and it’s seen that streak exaggerated on signs of demand strength from commercial business and U.S. defense spend. The commercial side of the business is gaining more ground, hitting $307M in 2Q24, up from $231.8M in the year ago quarter; the commercial side of the business saw a surge in demand, outpacing the growth in government business that we’re accustomed to seeing from Palantir. The government business is still on its way up, growing to $371M, up from $301.51M in the year ago period. Palantir is an American company through and through, so most of that commercial revenue growth was supported by U.S. commercial customers, which came in at 295, up from 161 a year ago. The following chart outlines the revenue per segment for Palantir since 1Q22.

A big part of the better performance on the commercial side is the AIP boot camps, which are Palantir’s go-to-market strategy. The strategy seems to be paying off big time, with 100 organizations signing up for AIPCon this past September. This isn’t to say that the government side of the business isn’t doing well. It’s doing pretty great, and rising geopolitical tensions in the Middle East are helping; earlier this year in May, the U.S. Army announced it would be extending Palantir’s existing MSS (Maven Smart System) contract for another five years. Palantir seems to be building itself up to be the industry go-to for infusing AI into the battlefield for defense, and has established good footing as part of Project Maven, which is the U.S. Army’s project to bring AI to defense, secondly, its cloud computing alliance with Oracle (ORCL). These are all positives that should support top-line expansion, but our downgrade is based on our belief that a lot of the positives have been priced into the stock and the outlook. So any miss-step or delay could have harsher consequences for Palantir at current levels.

Palantir is definitely one of our longer-term buy picks, but we don’t recommend investing in it at the current level. The Warp Speed effort, in particular, should revolutionize the industry and will be focused on manufacturing. Additionally, we should see a boost in profits with CEO Alex Karp’s focus on enterprise software business growth. Our concern lies in the near-term; management is guiding for 3Q24 revenue between $697M to $701m, comfortably ahead of consensus at $680.2M, and just raised FY24 guidance to the range of $2.74B to $2.75B versus consensus of $2.7B on higher U.S. commercial revenue guidance to represent a 47% Y/Y growth, at least. The better-than-expected guidance is impressive but comes with upward revisions in consensus expectations, too. Now, the average revenue estimate for Palantir is $701.13M. There are a lot of tailwinds working for Palantir’s benefit, but high market expectations are a double-edged sword, and it places the stock at a higher risk profile, in our opinion. We think the stock is too expensive to touch now and see potential moderation, considering the pressure for Palantir to continue its upward trajectory.

(Premium) Valuation & (Bearish) Word on Wall Street

Palantir trades at premium multiples; the stock trades at EV/C2024 Sales of 32.2x, compared to its ratio of 14.1x last November. The stock is comfortably the most expensive name in our software coverage. Wall Street is more bearish on the stock, similar to the case late last year, but with more hold-ratings. Of the 19 analysts covering the stock, four are buy-rated, nine are hold-rated, and the remaining are sell-rated, compared to five buys, six holds, and six sells last November. The stock’s valuation can be thanked for the higher number of bears, as “shares now trade at a multiple of nearly 95 times next year’s earnings estimates.” The sell-side price targets on Palantir also tell a lot about the need for a stock correction; the median and mean sell-side price target is $28. This is an indicator of the stock potentially being overvalued, i.e., the market has higher expectations than analysts do. The sell-side price targets confirm the bearish street sentiment, as does the stock’s high price-to-operating cash flow ratio of 55.

The following charts outline PLTR’s sell-side ratings and price-targets.

What to do with the stock?

Bulls and bears are going head-to-head on Palantir, and the stock shows no signs of slowing down. Palantir is uniquely positioned to leverage the opportunity from the biggest U.S. defense contractors, and we don’t think Palantir is going anywhere with more focus from Karp on the enterprise software side of the business, and the Palantir is fit for the U.S. government’s post-Cold War strategy. We just think that the market is getting ahead of itself in the near-term and entering a red zone for us. We think investors are better positioned on the sidelines for now.

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Analyst’s 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.

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