Palantir Technologies (PLTR) stock has witnessed a sharp correction in the last six months. During this period, the stock has declined by over 40%.
Some key metrics might still indicate that PLTR stock valuations are stretched. As an example, the stock trades at a forward price-to-earnings ratio of 88 (for December 2021).
Furthermore, for 2021, the company has guided for revenue of $1.53 billion. Considering the current market capitalization of $26 billion, PLTR stock is trading at 17 times 2021 revenue.
While these metrics might point to further correction in the stock, I am bullish on exposure to PLTR stock at current levels. The valuation perspective is incomplete without considering the following two factors.
First, Palantir Technologies is an innovator. These companies deserve a valuation premium. The price-to-earnings ratio might not be the best indicator.
Further, Palantir Technologies is on a high-growth trajectory. There are reasons to believe that growth can potentially accelerate in the coming years. This makes the stock attractive after a meaningful correction.
Let’s talk about some of the factors that make PLTR stock attractive.
Revenue Visibility and Cash Flow Upside
For 2021, Palantir has guided for revenue of $1.53 billion. The company also believes that it’s positioned to deliver an adjusted free cash flow of over $400 million. Ultimately, it’s cash flows that determine the valuation. From that perspective, the outlook looks optimistic.
Another important point to note is that Palantir has guided for annual revenue growth in excess of 30% for the next four years. The markets might still be looking at higher growth considering the valuation. However, 30% seems like a base-case scenario. There are catalysts that can accelerate growth.
As an example, growth in cryptocurrency has been robust in the recent past. The company considers Palantir Foundry as the “next-generation software for next-generation finance.” One of the challenges faced by the cryptocurrency industry is billions being lost due to hacks and scams. The company’s software provides the solution. Banks have already been using Foundry for anti-money laundering solutions.
Another reason to believe in possible growth acceleration is the order book. As of Q3 2021, Palantir reported an order backlog of $3.6 billion. On a year-over-year basis, the company’s backlog increased by 50%.
Palantir has meaningful exposure to some of the critical sectors of the economy. This includes healthcare, defense, and retail, among others. Government contracts can be recurring in nature and will boost the backlog in the coming years.
If this acceleration sustains, the company will have clear revenue and cash flow visibility. Additionally, Palantir has witnessed key margin expansion. For Q3 2021, the company’s adjusted EBITDA margin was 30%. The implication is sustained improvement in free cash flows.
Let’s look at some ball-park estimates. For 2021, Palantir has guided for an adjusted free cash flow of over $400 million; Assuming that free cash flow growth is in-sync with revenue growth of 30% over the next four years. This would imply free cash flow of $1.1 billion by 2025.
However, if there is margin improvement coupled with acceleration in growth, free cash flows can be in the region of $1.5 billion to $2.0 billion by 2025. Clearly, the business seems like a long-term cash flow machine.
Wall Street’s Take
Turning to Wall Street, Palantir has a Moderate Sell consensus rating, based on one Buy, three Holds, and four Sell ratings assigned in the past three months. The average Palantir price target of $20.71 implies 59.6% upside potential.
Bottom Line
Palantir Technologies stock has been in a downtrend as market participants discount valuation concerns. For a technology company with a robust growth outlook, the selling seems to be overdone.
Growth in the order backlog coupled with acceleration in free cash flow are the key catalysts for stock trend reversal. Some exposure can be considered at current levels, with the downside risk likely to be minimal.
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