Palantir Q2: Focus on Cash Burn Rates (NYSE: PLTR)
Summary Q2 and thesis
Palantir Technologies Inc. (NYSE: PLTR) reported a mixed Q2. Revenue growth is very healthy in my view, although the company’s updated guidance has disappointed consensus expectations. Second-quarter revenue reached $473 million, growing 26% year-over-year and also slightly exceeding the consensus expectation of $471.72 million. Looking ahead, PLTR updated its third-quarter sales to be between $474 million and $475 million, down from consensus estimates of $508 million. For the full year 2022, its new forecast is now $1.9 billion in total revenue, just below analyst estimates of $1.98 billion.
For me, what is more worrying is the end result. It spent another quarter in the red, posting negative Adjusted EPS of $0.01. In addition, I also expect a loss of $0.20 per share for a full year given the trading conditions which will be detailed next. Looking further ahead, assuming a favorable trading climate, I expect it to return a small positive profit (say a few cents to a penny per share) in 2023.
As such, in the article, I will focus on analyzing its near-term cash burn rates based on the second quarter (“ER”) earnings release. The company currently has $2.4 billion in cash and no debt. And my conclusion is that it should have no trouble meeting its working capital needs, its CAPEX needs and its short-term OPEX needs.
Before we dive into the issues, let’s first review the positives. As mentioned above, topline has continued its robust growth in my opinion. Second-quarter revenue reached $473 million, up 26% year-on-year. At the same time, the company maintains a very healthy contract pipeline in both the government and commercial segments, as its Managing Director Shyam Sankar commented (abbreviated and underlined by me):
The contracts we have in our pipeline are key to meeting the challenges facing the West. Our government operations reached $263 million in revenue in the second quarter, up 9% quarter over quarter. More generally, in the commercial and government sectors, healthcare has become a large and rapidly growing business, generating approximately $153 million in revenue in the first half of 2022, compared to $42 million in the first half of 2020 at the start of the pandemic. This represents a compound annual growth rate of 91%.
The number of customers rose to 304, an increase of almost 80% compared to 169 last year. As the company grows, it benefits from the breadth of the economy, as you can see from its asset turnover rates below. PLTR’s asset turnover has been as low as 0.47 during the pandemic. And it has been generally around 0.48 to 0.49 in recent quarters. And you can see, an overall upward trend as it gains momentum and its current asset utilization peaks at 0.52.
For the future, the company’s management has ambitious growth targets. They forecast sales to reach $1.9 billion for the full year of 2022, a year-over-year growth of 23% from $1.54 billion in 2021. I share their optimism given the deal pipeline and company size. But I also see some uncertainties ahead, including intensifying competition and rising operating costs, which brings me to my next section to examine its cash burn rates.
Cash burn rate
To fuel its growth, PLTR is aggressively spending on both growth CAPEX and OPEX (operating expenses) as summarized in the table below. The top panel of the chart shows PLTR CAPEX spending over the past quarters. Its CAPEX expenses were consistently around or below $5 million on a quarterly basis through 2022, then jumped to $15.2 million in the last quarter. Compared to its operating cash flow of $35.5 million in the last quarter (shown in the middle of the panel), its free cash flow was a positive $20 million, which is good news.
The even better news is that PLTR doesn’t need to spend too much on maintenance CAPEX, as you can see from the bottom panel of the chart. If we approach its maintenance CAPEX with depreciation, then its maintenance CAPEX cost averages only around $3 million per quarter. As a result, a large portion of its CAPEX expenses are growth expenses.
Although the bad news is that as a software as a service (“SaaS”) company, it has to spend a lot on OPEX, as you can see in the following table. The company has spent hundreds of millions of dollars developing new research software. Namely, its total operating expenses have been consistently at the $390 million level in recent quarters and its research and development expenses at the $88 million level.
You can further divide both CAPEX and OPEX into maintenance part and growth part, and an argument can be made to add the growth CAPEX and OPEX part in revenue to get owner revenue. The analysis of my previous article was done in this line of thinking, and readers can find more details there. Here, we’ll just focus on accounting profits and see if its current finances can cover its short-term cash burn, as we will next.
Balance sheet statement
In the second quarter, its cash and cash equivalents were approximately $2.4 billion. He is debt free. And there’s an additional $950 of liquidity from its revolving credit facility. All things considered, it should be able to meet its CAPEX and OPEX for quite some time, as CFO Dave Glazer commented (abbreviated and underlined by me):
On a rolling 12-month basis, we generated $314 million in adjusted free cash flow. We ended the second quarter with $2.4 billion in cash and cash equivalents and zero debt. In July, we expanded our revolving credit facility by adding a new additional $450 million deferred draw term loan facility, which provides additional liquidity up to $950 million and remains fully undrawn. As we pointed out last quarter, our balance sheet places us in a unique position to take advantage of opportunities that may arise from the broader macroeconomic environment.
A final word on evaluation. Due to its negative EPS, the typical P/E ratio is not too significant here. In terms of cash flow, PLTR generated $314 million of adjusted free cash flow (“FCF”) on a TTM basis, which translates to $0.15 per share. Given the small magnitude of FCF and the expected variance, the typical price/FCF ratio (which would be 59.5x at the price of this write-up if you really want a number) doesn’t apply very well either.
So here we are going to take a look at the head line evaluation metrics. The chart below compares its P/S ratio to peers like The Trade Desk (TTD) and Google (GOOG, GOOGL). Its P/S of 10.1x is almost 2x more expensive than GOOG’s 5.3x, but over 40% lower than TTD’s 17x. As detailed in my previous article, I believe that PLTR is now more reasonably priced (and TTD is still priced perfectly), and its current valuation can be justified by a few years of sustained growth, even if the valuation returns to the market average.
Final thoughts and other risks
Overall, I have mixed feelings about PLTR after its second quarter results and will stand by my “hold” recommendation. On the plus side, as her customer base grows, she will reap the benefits of scaling the economy. As a SaaS company, it doesn’t need to spend too much on maintenance CAPEX. All things considered, current finances are strong and it should be able to meet its CAPEX, OPEX and other obligations at current cash burn rates for some time.
On the negative side, it has to spend a lot on OPEX and new software research development, and it has yet to generate positive profits. Valuation isn’t cheap and needs a few more years of robust growth to catch up, but recent corrections have deflated the valuation bubble (with a P/S multiple exceeding 35x) to a large extent.
In addition to the above risks, some macroeconomic uncertainties also lie ahead. Management mentioned that as organizations around the world face increased pressure, there could be a slower pace of spending and longer sales cycles. At the same time, the strengthening of the US dollar to a 20-year high has created headwinds, as it has for other global businesses.