Earnings Review - November 19, 2022
Brief market commentary and a look into earnings from PLTR, TTD, and UPST
The market has been grinding higher since the lows made on October 13, 2022. The S&P 500 is above its 50-day moving average, and approaching its 200-day moving average.
The last time the market approached the 200-day moving average was at the end of the summer rally. Inflation results open the possibility that this time may be different.
The October CPI (consumer price index) report was released on November 10th, 2022. The results:
Month over month: +0.4% vs +0.7% expected
Year over year: +7.7% vs 8.0% expected
Core CPI m/m: +0.3% vs. +0.5% expected
Core CPI y/y: +6.3% vs. +6.6% expected
While the numbers are still high, the forward-looking picture is more palatable: the 0.4% monthly rate implies a 4.8% forward annual rate.
The market celebrated the report. Bonds rallied, driving the yield on the 10-year Treasury note to 3.83% from 4.15%, the biggest one-day decline since March 2009. Equity markets posted some of the best days on record, with the S&P 500 up 5.5% and the Nasdaq climbing 7.4%.
On November 15th, the October PPI (producer price index) report showed a month over month increase of +0.2% vs 0.4% expected. The producer index is a leading indicator, as it shows the input costs that eventually make it to the marketplace.
The Fed has opened the door to smaller rate increases in the future, implying that the next rate increase may be 50 bps instead of another 75 bps. A 50 bps hike would set the federal funds rate in a range of 4.25-4.50%. The Fed has stated they are data-dependent and that they aim to keep rates higher for longer. They are in a tough spot. Any rally in the markets has a counter-effect to their efforts. When markets rally, rates go lower and financial conditions are loosened. Expect the Fed to keep a firm tone in an attempt of capping an excitement.
The economy may continue to weaken. Markets usually bottom 6-9 months before the actual economy.
CY Q3 2022 Results
Over the last two weeks, three portfolio companies reported earnings: Palantir, The Trade Desk, and Upstart.
Palantir
Palantir’s Q3 results and a summary of their financials are shown below.
Performance for the quarter was acceptable given the macroeconomic climate. There are a few trends to watch out for.
Year-over-year revenue growth of 22% is below management’s long-term guidance of 30%.
Gross margins have been weakening, presumably due to the onboarding of new customers. We’ll look for the gross margin to stabilize around current levels.
Profitability is ok historically, but Q3’s EBITDA margin is on the decline, down to 18% from 26%. FCF margins are similarly down.
As for the management’s guidance, Palantir expects:
Q4 revenue of $504 million, y/y +14%
Full year 2022 revenue of $1,907 million, y/y +19%
On the financials, we need to look for margins to stabilize and need growth to accelerate (the strong dollar has been a headwind here, and can become a tailwind if it weakens)
The investment thesis remains intact. Palantir’s solutions stitch together disparate systems to give large, complex enterprises an operating system for their business. Palantir gathers data, makes it digestible, and drives decisions.
Companies bring these on as a long term investment. Their top 20 customers pay an average of $48 million per year. And they are seeing significant benefits from doing so. Leveraging Palantir’s Foundry, Tyson Foods completed over 20 projects in 24 months for over $200 million in savings. A smaller commercial example: Jacobs adjusted operations at their sites to save over $300 thousand per year.
Palantir’s customers consider having Palantir as a competitive advantage. Although the path may be lumpy, it seems to be very durable.
The Trade Desk
The Trade Desk’s Q3 results and a summary of their financials are shown below.
Assessment of Q3:
Revenue growth continued to show resilience, particularly in light of the general slowdown in advertising (as seen in many other companies results).
Gross margins are improving, showing their leverage and/or pricing power (i.e. they are not giving discounts to buy growth)
Profitability is strong, with EBITDA margins > 40% and FCF margins > 30%
Guidance came in very strong. Management expects:
Q4 revenue of $490 million, +24% y/y
Full year revenue of $1,577 million, +32% y/y
The Trade Desk is a great example of an asset-light growth compounder. The business is growing rapidly (>30%), very profitable (>40% EBITDA margins), and doesn’t necessarily require reinvestment in existing solutions (can reinvest in new offerings). They have been building up a sizable cash position, up to $1,055 million from $245 million just two years ago.
They also have a very long runway. The Trade Desk is an ads marketplace, where buyers can purchase ads across many different platforms and see the return on their investment. While many of the competitors (Google, Meta, Twitter, etc) have closed platforms, TTD seeks to be an open platform, allowing selection across many different advertising properties.
Upstart
Upstart’s Q3 results and a summary of their financials are shown below.
All is not well at Upstart. Q3 performance was very poor. Management seems to have limited visibility, and is unable to predict their business results out one quarter.
Revenue came in at $157 million, down 31% y/y
Gross margins, although still very high, are trending down, likely indicating pricing pressure (perhaps discounting the fees they take on loans)
They are losing money. EBITDA and FCF margins are negative.
As for guidance, Upstart is expecting:
Q4 revenue of $135 million, a further slowdown representing -59% y/y
Needless to say, Upstart’s business has been deteriorating. The main culprit behind this is the rapidly rising interest rates. As rates rise, the yields on new loans go up.
As rates have been rising, multiple things happen:
The present value of loans made in the past goes down, which affects the performance of the portfolio. This is the same phenomenon that has bonds down this year (ex. TLT -30% ytd).
Institutional investors have been holding off on investing, knowing that they can get better rates in the near future. This constrains the capital that Upstart is able to place. If there is no capital, Upstart cannot process loans and cannot charge a fee.
Rates offered to consumers have to go up. Consumers are less likely to convert. Upstart’s conversion rates go down.
As conversion rates go down, Upstart adjusts marketing spend. Less marketing attracts fewer borrowers.
On top of this, Upstart’s initial focus has been on unsecured personal loans. During a recession, these can be at significant risk of default. There is limited recourse.
The result is a perfect storm for Upstart.
Upstart is responding. Knowing the business is cyclical, they had bolstered up their balance sheet during the good times. They started using their balance sheet to have some flexibility. They continue to improve operations, automating an increasing % of loans made. This investment becomes more valuable as they grow in scale, i.e. the number of loans processed increases. They continue to expand into auto loans and small business loans.
At the core, Upstart is leveraging data to make better informed decisions. They are applying it to financial underwriting. From this perspective, the thesis remains sound. Upstart has a viable product, with a very large market, and are doing what they can to execute.
The issue is that their current business model is very susceptible to macroeconomic conditions, things that are beyond their control. To be fair, this has been one of the most extreme periods of change in history. As bad as things are now, as macroeconomic conditions reverse, Upstart will once again be turbocharged. That being said, there is significant value in having a predictable, stable, and durable business.
Closing
Patience is one of the myriad of characteristics required to be a good investor. Every company, every investment, has its ups and downs. While the noise can be very loud, it is important to keep perspective. Investors can reinforce their patience by building conviction. What will things look like in the next few years or over your expected time horizon?
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Torre Financial is an independent investment advisory firm focused on emerging and established compounders.
Federico Torre
Torre Financial
federico@torrefinancial.com
https://torrefinancial.com
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