Palantir Technologies Inc. (PLTR) shot to fame early this year as a company that would benefit from the increasing adoption of artificial intelligence technology. While the company has faced some challenges due to high interest rates, its market value has increased by more than 180% in 2023, highlighting the strong momentum behind it amid the improving prospects for the tech sector.
The company's recent financial success has come on the back of strategic partnerships it has formed with key customers. Palantir initially focused on serving government clients, offering a big data platform that turns information into practical insights. However, the company has recently expanded its reach into civilian government contracting, opening new doors for growth. Although the stock is not cheaply valued, a closer look at Palantir's fundamentals suggests it deserves to trade at rich valuation multiples.
Strategic expansion across key sectors and its impact on growth
While government contracts have played a significant role in Palantir's growth, its U.S. commercial business continues to deliver impressive results. In the second quarter, the company's U.S. commercial business recorded year-over-year growth of 20%, outpacing the 10% growth in U.S. government revenue during the same period. Palantir successfully secured deals across approximately 30 diverse industries within the U.S. commercial sector. These industries include pharmaceuticals, energy, consumer staples, utilities, health care, construction, automotive and transportation infrastructure, which shows the expanding reach of its software solutions.
Exhibit 1: Palantir’s U.S. revenue growth by category
Source: Earnings Presentation
Recently, Palantir achieved a significant milestone through its strategic partnership with PricewaterhouseCoopers, a globally recognized professional services firm. This partnership represents a strategic alignment where PwC will leverage Palantir Foundry, a versatile platform that seamlessly integrates data, analytics and operational processes, to help improve the experience of its clients. Additionally, PwC will harness Palantir's advanced artificial intelligence platform, an interactive large language model developed to enable clients with the ability to not only identify but also quickly execute strategies for value creation and operational transformation. This partnership symbolizes the convergence of PwC's extensive industry-specific expertise with Palantir's cutting-edge software solutions.
In the energy sector, AI is playing a pivotal role in transforming the industry by tackling its inherent variability and uncertainty and driving the widespread adoption of renewable energy sources. According to insights from McKinsey & Company, the integration of AI and digitalization has the potential to boost asset productivity by 20% while also reduce maintenance costs by 10%. Moreover, AI's ability to accurately predict weather patterns provides grid operators with valuable insights into the availability of wind and solar resources, thereby enhancing the overall reliability of the energy network. The AI in the energy and power market is poised for substantial growth, with Research & Markets projecting an impressive annual growth of 24.68% for this market through 2028.
With over a decade of experience in the energy sector, Palantir has emerged as a key player in helping a diverse range of clients seize opportunities across the entire value chain. At the core of its energy-focused approach is Foundry, its flagship product that functions as an operating system. The softare's versatile capabilities empower energy companies to optimize their operations, reduce emissions, enhance efficiency, and accelerate their transition toward a net-zero future. Palantir has established strategic partnerships with leading energy companies such as BP PLC (BP), Kinder Morgan (KMI) and Exxon Mobil Corp. (XOM), consistently delivering tangible value through the utilization of Foundry. The software's proficiency also extends to addressing complex challenges such as wildfire preparedness, optimizing solar power production and implementing digital twin applications.
Palantir's strategy of diversifying its commercial portfolio and reducing reliance on government contracts has led to a recent partnership with Gemelli Generator Real World Data, the research branch of Fondazione Policlinico Universitario. This collaboration aims to harness the potential of artificial intelligence in the field of digital medicine research, with the primary goal of improving patient care and health outcomes. At the core of this partnership lies Policlinico Gemelli's renowned digital research center, Generator RWD, which will use Palantir Foundry as a platform for managing complex health care data. This strategic initiative underscores Palantir's commitment to driving transformative advancements in health care, ultimately benefiting patient well-being and advancing medical science.
The health care industry has witnessed a rapid integration of AI-driven solutions in recent years, ranging from more accurate medical diagnoses to expediting drug discovery. In 2021, Statista noted the global AI health care market was valued at approximately $11 billion. It is anticipated to reach a value of nearly $188 billion by 2030.
Exhibit 2: AI in healthcare market size worldwide (2021 to 2030)
Palantir's presence in the health care sector has seen significant growth, with the company reporting a 93% year-over-year increase in revenue from this sector in the second quarter. Foundry is being employed in numerous health care facilities for tasks such as generating nurse schedules and forecasting patient placements. The company's management team highlighted a few examples during the quarterly earnings call, including how HCA now creates nurse schedules in just one hour per month, down from 10 to 20 hours. Tampa General has reduced patient hold times by 28% and cut the time spent managing patient placements by 83%, while Cleveland Clinic has accepted an 8.5% increase in patient transfers from other hospitals in just four months since the launch of Foundry.
As Palantir's technology gains traction, its U.S. commercial customer base expanded 35% year over year in the second quarter. There is reason to believe the company’s customer base growth is nowhere near maturity.
Exhibit 3: Customer count
Source: Earnings presentation
Palantir’s aggressive expansion into new business verticals and fast-growing business sectors is opening new doors, but it remains focused on growing its government business as well.
Palantir's strategic partnerships in the government sector have played a pivotal role in helping the company maintain its strong growth momentum in recent quarters. In June, the company secured a contract with the U.S. Special Operations Command worth up to $463 million. The contract is geared toward providing advanced technology solutions to enhance the enterprise capabilities of USSOCOM personnel and maintain their competitive edge. Palantir is focused on driving innovation within its Defense Portfolio, as demonstrated by its pioneering advancements in LLMs. The company also secured new contract awards worth $110 million from the U.S. Space Force.
On a global scale, defense organizations are increasingly investing in AI technologies for enhanced decision-making and efficiency. A study by Precedence Research projects AI in the military market will reach a value of $22.6 billion in the next decade with the AI technology increasingly showing promising signs in its ability to transform the defense sector.
Exhibit 4: AI in military market size
Source: Precedence Research
Further, the company’s international government business continues to expand driven by its partnership with the U.K. government.
Strengthening its defense portfolio, Palantir announced a partnership with Babcock International Group (BAB) in September, marking its first collaboration with a company in the U.K.'s Defense Industrial Base. This is a significant initiative that harnesses Palantir's AI-enabled software, known as Palantir AIP, to enhance Babcock's digital defense capabilities. The collaboration aims to transform data management, integration, modeling and the development of data-driven solutions.
Through this initiative, Babcock will gain valuable insights into supply chains, asset management, sustainability impact and carbon footprint. Additionally, the partnership will facilitate closer coordination with customers and enable a deeper understanding and utilization of data, strengthening Palantir’s involvement in critical defense missions. For example, within the Defense Support Group, Palantir's contribution is helping Babcock implement an intelligent data approach, improving fleet availability and identifying issues in real-time throughout the lifecycle of military equipment, including ships and armored vehicles. By leveraging the right technology for maximum impact, the partnership aims to optimize performance mitigate risks, and deliver exceptional value for the British Army across various aspects, including equipment support and maintenance, readiness, spare provision, requisition and training contracts.
In a parallel move, Palantir selected the United Kingdom as the location for its European headquarters for AI research and development, further solidifying its presence in the important market.
Palantir's engagement with the U.K. government during the COVID-19 pandemic, particularly its involvement in managing the vaccine rollout, has positioned it as a reliable contractor. The company is now a top pick for the National Health Service’s five-year contract with the possibility of a two-year extension, valued at up to 480 million pounds ($579 million). This prospective contract has the potential of establishing one of the world's largest repositories of health data, positioning the company as a pivotal partner in modernizing the U.K.'s health care system which runs on an annual budget of 160 billion pounds.
However, its association with the NHS has not been without challenges as the company has drawn scrutiny from civil rights and patient advocacy groups. These organizations have voiced concerns regarding the privacy of patient data. The primary points of contention have revolved around the transparency of data sharing, the purposes for which the data is used and the ability of patients to exercise their right to opt out of data sharing. In 2020, a leaked contract brought to light that Palantir had been granted access to sensitive data encompassing information about patients, employees and the general public, with the intention of aiding the health service in its battle against the pandemic. Public opinion, as evident in surveys, shows that a majority of Britons have concerns about expanding privatization within the health care sector.
Palantir has defended the quality of its work, stating, “We are now helping to reduce the N.H.S. backlog, cut the amount of time nurses and doctors need to spend on administrative tasks and speed up cancer diagnosis — all while rigorously protecting data privacy.”
Despite facing criticism, the contract is currently pending final approvals and legal arrangements. The government is likely to declare Palantir as the chosen bidder, which could potentially represent a notable milestone for the company.
Thoughts on valuation
Palantir is not cheaply valued with a forward price-earnings ratio of 77, but this is the cheapest the stock has been since its market debut. Despite facing several risks, including recession fears and high interest rates, the company has grown its revenue in each of the last 10 quarters, which is a testament to the strong fundamentals of the market in which it operates. Wall Street analysts have boosted their earnings estimates for Palantir’s next fiscal year 13 times in the last three months with no negative revisions, while revenue projections have been boosted 10 times against four negative revisions during the same period. The overwhelmingly positive earnings revisions are likely to act as a catalyst, driving Palantir stock price higher in the foreseeable future as these favorable earnings events more often than not boost investor sentiment.
Palantir deserves to trade at premium valuation multiples given how it is diversifying into fast-growing business sectors while continuing to win new government contracts. With AI integration into key business sectors such as defense and health care still in the infant stage, Palantir enjoys a long runway to growth. Aided by a strong revenue base coming from government agencies, Palantir is well-positioned to grow for many years to come.
Originally published on GuruFocus.com