Palantir Technologies (NYSE:PLTR) has risen 10% since my last article that focused on its free cash flow (FCF). The market will value PLTR stock much higher once it sees Palantir is highly profitable on a positive FCF basis.
I estimate that PLTR stock will climb up to another 36% from here, due to its forecast FCF profitability next year.
Moreover, Palantir’s FCF is driven by higher sales. Its sales growth shows that its bid data analysis software is what government agencies and enterprises want.
For example, analysts are forecasting sales growth of about 32% next year to $1.41 billion from $1.07 in 2020. That should be enough to put the company in positive FCF territory.
For example, in Q3 Palantir’s revenue rose 52% year-over-year and its adjusted operating income was $73.1 million in Q3. But FCF, although negative, improved 50% over Q2 by falling from negative $116 million to negative $53.5 million.
A Closer Look at PLTR Stock
This works out to an increase in FCF of $62.5 million over Q2. This is correlated with the Q3 sales gain. For example, Q3 sales rose by $37.5 million to $289.4 million over Q2.
However, you can see that Palantir’s FCF portion of total sales rose (i.e., its margins). The $62.5 million FCF gain was greater than the $37.5 million sales gain by $25 million.
Therefore, the breakeven FCF level is at a sales level of $264.4 million quarterly (i.e., $289.4 million minus $25 million). This works to $1,057.6 million in total sales going forward.
We can draw some inferences about next year. For example, if sales rise by $340 million to $1.41 billion (see above), then FCF will be $352.4 million. This is seen by deducting $1.0576 billion (FCF breakeven) from $1.41 billion forecast sales next year.
In other words, we can expect Palantir to make a 25% positive FCF cash flow margin next year (by dividing $340 million by the forecast $1.41 billion in sales).
In addition, Palantir just won a $300 million contract, its largest ever. Even if this is a 3-year contract, it will represent 7% of the company’s $1.41 2021 sales.
What Palantir Stock Is Worth
Now that we can forecast its FCF, it is possible to value PLTR stock more precisely. For example, For example, let’s forecast that Palantir will be FCF profitable over the next five years. And let’s assume its FCF margins rise to 35% on average.
Now if sales also grow to $2.5 billion on average over the next five years, FCF will average $875 million. We can use this estimate to come up with a forecast value for PLTR stock.
For example, let’s assume the stock rises so that its FCF yield is 1.5% (i.e., FCF divided by market cap). Therefore, $875 million divided by 1.5% works out to a market capitalization of $58.33 billion.
That represents a gain of 30% over Palantir’s market cap today of just $45 billion. Even if we assume a 2.0% FCF yield, PLTR stock will still be worth 13% more at $51 billion.
In other words, Palantir is worth between $30.77 per share to $35.30 (i.e., 18.5% to 35.9% above today’s price on Dec. 18).
What To Do With PLTR Stock
Analysts are starting to wonder about the high $45 billion market capitalization for PLTR stock.
Some analysts still do not believe that the company will start producing free cash flow next year. For example, TipRanks.com says that the average price target of six analysts in the past three months is $13.83. That represents a decline of over 49% from today’s price.
This is similar to the price target average from a survey by Marketbeat.com. In other words, analysts do not believe that PLTR stock is worth this high a price.
In other words, nobody is a believer yet in Palantir’s ability to make free cash flow. Nevertheless, the market is able to see that the company is on a path to positive FCF. It is worth between 19% and 36% higher than today’s price, assuming FCF keeps on growing.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Mark Hake runs the Total Yield Value Guide which you can review here.
