Editor:

Palantir announced it would release its Q1 results on May 8th following the market close.

Since the stock trades at similar levels to when it released the Q4 results that preceded a spike, it could be helpful to understand where we are in terms of valuation.

Palantir currently trades at $8, which consists of ~7x EV/Sales and ~29x EV/EBIT adj. on 2023 analysts’ consensus numbers.

In the table below you can see the EV/Sales and EV/EBIT adj. valuation ranges at different prices:

In the previous article (Palantir DCF: 20+20 is not 10+30), we showed that Palantir’s Reverse DCF implies a 20% Revenue growth, which seems pessimistic and leaves a substantial upside. However, to have the full picture we also need to see how Palantir’s valuation is related to other similar companies.

How appealing is Palantir compared to its peers?

Cloud Sector Valuation

As a reminder, the Rule of 40 Score represents the sum of the Revenue Growth Rate and the FCF or EBIT adj. Margin. This is the key “ingredient” for SaaS valuations.

Palantir’s “Rule of 40 Score” has decreased from 72% to 46% as a combination of slower growth and relatively lower margins. This has an impact on the “fair multiple” that the market can attribute to Palantir.

Compared to its peers, Palantir’s 7x EV/Sales seems appropriate for its current 40% Rule of 40 Score.

Unless Palantir significantly exceeds its Guidance for Revenue and EBIT adj. Margin, there is relatively little room for further upside from a purely relative value perspective.

By making one step back we see that the overall SaaS market trades at a median of 5.4x, which leaves some upside as the sector recovers from the recent crisis.

Catching up with Servicenow

It is particularly interesting to see how Palantir’s multiple relates to that of Servicenow, which I consider the closest comparable.

Palantir currently trades at ~35% discount on the 11x EV/Sales of Servicenow.

The discount is deserved as Palantir is showing a worse combination of growth and margins. If Palantir accelerates its growth, I don’t see why it should not trade in line with Servicenow’s current 11x EV/Sales, which is also the long-term median value.

Interestingly, Servicenow became GAAP profitable in FY19 at ~$3bn annual Revenue, while Palantir should become GAAP profitable in FY23 with ~$2.3bn.

Palantir vs. the gravity force

In the previous article (Palantir Competes vs. a Tough Competitor), we showed how the yield of the 10y Treasury heavily affects equity valuations, especially for those labeled “growth.”

The 10y Treasury Yield has decreased from the peak of 4.2% to 3.5%, which alleviates the pressure on Palantir’s valuation.

There are hints supporting the fact that yields could decrease, thanks to a reduction in inflation, which in turn creates the condition to avoid further interest rate hikes from the FED.

A decrease in interest rates could also be caused by a shock in the economy or a “flight to safety” in Treasury Notes, triggered by a geopolitical event from Russia/Ukraine or China/Taiwan.

Paradoxically, a break in the economic machine could be a bullish catalyst.

Key Catalysts

There are three key catalysts that I consider could support Palantir’s valuation in the coming months:

Potential S&P500 inclusion next year thanks to a change in the index methodology. Thanks to a recent update, the S&P 500 will also include companies having a separate class of shares, like Palantir’s F Shares reserved to the Founders. The only missing criteria is now achieving a cumulated GAAP Profit in the next three quarters. Continued execution on the GAAP profitability front would facilitate the interest of investors.

“The sum of the most recent four consecutive quarters’ Generally Accepted Accounting Principles (GAAP) earnings (net income excluding discontinued operations) should be positive as should the most recent quarter.” - S&P 500 Methodology

Potential immense defense deals. Palantir is in the final stage of the crucial TITAN contract, which would basically make Palantir a Software Prime. Furthermore, Palantir’s significant contribution to Ukraine seems to strengthen its relationship with NATO countries that are worried about a further escalation in Ukraine and the rising tensions in the South China Sea.

“Although this [TITAN] is a piece of hardware (a truck), its key capabilities come from its software.” - War on the Rocks

Consolidation of the narrative that Palantir is a leading AI company. Despite this being nothing new for us, there is a significant narrative shift in motion that could facilitate both sales and the discovery of the stock. While there are many software companies, there are very few “pure AI plays” in the market like Palantir.

Conclusion

From a peer comparison perspective, Palantir’s current numbers don’t offer much space for revaluation. However, Palantir is sitting on key trends that are extremely favorable conditions for growth recovery and support the narrative shift from “unprofitable growth tech” to “AI profitable SaaS,” a key player in defense.

If the thesis is right, it’s only a matter of time and patience.

“We believe that the full impact and significance of this change will reveal itself over time.” - Alex Karp, S&P500 Letter

Yours,
Arny

View expresses are my own and do not represent Financial Advice in any way.
I own (many) PLTR stocks.

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