Late in November 2022, OpenAI opened its artificial intelligence chatbot, ChatGPT, to the general public, and the rest may very well have become history. The application took the world by storm. It amassed 1 million users in five days and 100 million monthly active users only two months into its launch to become the fastest-growing application in history.
The generative AI-powered application’s capability to provide (surprisingly) human-like responses to user requests fascinated the general public with the possibilities of the technology. With the potential to be as revolutionary as the steam engine and electricity, this field has understandably garnered massive attention from investors who are reluctant to miss the bus on such a watershed development in the history of humankind.
So, when a speculative enterprise artificial intelligence (AI) software company named C3.ai, Inc. (AI) announced the launch of its generative AI product suite on January 31, all hell broke loose.
Although the business is yet to find its way to profitability, AI seeks to differentiate itself from other vendors that only provide piecemeal solutions by providing an end-to-end platform-as-a-service to develop, deploy, and operate large-scale turnkey industry-specific AI applications. Hence, the company has positioned itself to cater to a large addressable market which has caused investors to be bullish about its prospects.
The stock’s recent popularity is evident from its 55.8% gain over the past month to close the last trading session at $21.63.
Let’s delve deeper to find out if the fundamentals of AI are strong enough to justify and sustain the hype.
Weak Financials
For the second quarter of fiscal 2023, which ended October 31, 2022, despite a 7.1% year-over-year increase in revenue to $62.41 million, AI reported a 1.5% year-over-year decline in gross profit to $41.66 million. During the same period, the company’s non-GAAP loss from operations came in at $14.96 million, while its non-GAAP net loss amounted to $11.85 million, or $0.11 per share.
AI’s total assets stood at $1.10 billion as of October 31, 2022, compared to $1.17 billion as of April 30, 2022.
Elusive Profitability
Although AI’s trailing 12-month gross profit margin of 72.62% is 47.7% higher than the industry average of 49.18%, the company is yet to operate at a scale and achieve enough penetration in the AI enterprise software market for its gross profits to offset its operating expenses.
AI’s trailing 12-month EBITDA and net income margins of negative 91.02% and 88.43% compare unfavorably to the respective industry averages of 11.22% and 2.89%.
In terms of the trailing 12-month ROCE, ROTC, and ROTA, AI also underperforms the industry averages of 4.75%, 3.01%, and 1.36%, respectively.
Stretched Valuation
The recent frenzy surrounding artificial intelligence has stretched the valuation of AI stock to levels that the company might find tough to justify in the foreseeable future.
In terms of forward EV/Sales, AI is currently trading at 5.96x, 108.5% higher than the industry average of 2.86x. Also, the stock’s forward Price/Sales multiple of 9.13 compares unfavorably with the industry average of 2.81.
Bleak Outlook
Analysts expect AI’s revenue for the third quarter of fiscal 2023, ended January 31, to come in at $64.25 million, indicating a 7.9% decline year-over-year. During the same period, the company’s loss per share is expected to worsen threefold to $0.22.
AI expects to operate profitably on a non-GAAP basis only by the end of fiscal 2024. In line with those expectations, Street expects the company to keep reporting net losses until fiscal 2025.
POWR Ratings Reflect Weakness
AI’s fundamental weakness is reflected in its overall F rating, which equates to a Strong Sell in our proprietary POWR Ratings system. The POWR Ratings are calculated considering 118 different factors, with each factor weighted to an optimal degree.
Our proprietary rating system also evaluates each stock based on eight different categories. AI has grade D for Value and Quality, owing to its stretched valuation and lower profitability relative to its peers.
AI also has a D grade for Stability, consistent with its beta of 1.50 and relatively high spread between its 52-week high and low prices of $30.92 and $10.16, respectively.
Although the stock is currently trading above its 50-day and 200-day moving averages of $15.65 and $16.12, respectively, its massive drawdown of 9.3% during the last trading session is responsible for its D rating for Momentum.
Unsurprisingly, AI is ranked last of 25 stocks in the Software - SAAS industry.
Beyond what has been discussed above, additional ratings for the Growth and Sentiment of AI can be found here.
Looming Uncertainties
In addition to macroeconomic headwinds making near-term prospects for growth businesses such as AI uncertain at best, the company is also in the process of adjusting to strategic changes it has implemented in its pricing model and sales organization.
AI has transitioned from a subscription-based pricing model to a consumption-based pricing model. While the company believes that this shift would increase the number and frequency of small transactions from a broader customer base for long-term revenue growth, potential spending cuts by high-profile clients during a probable economic slowdown might put the short-term effectiveness of the model into question.
AI largely restructured the global sales organization comprising highly technical domain experts. While the company believes the medium and long-term effect of this transition provides a substantial accelerator to revenue growth, it has also admitted that revenue growth and RPO would decrease in the short term.
Lastly, according to Geoff Lewis of Bedrock Capital, incumbent companies, which provide the infrastructure and computing power for running the AI algorithms, are better positioned to benefit from the artificial intelligence gold rush compared to the plethora of smaller firms designing the algorithms and front-end applications.
Bottom Line
Hence in view of the above, despite AI’s potential to serve its large addressable market, its near-term prospects seem uncertain.
In addition, given its poor profit margins and high valuation, we believe it would be wise to avoid the stock now.
Stocks to Consider Instead of C3.ai, Inc. (AI)
Unfortunately, the odds of C3.ai outperforming in the weeks and months ahead are greatly compromised. However, there are many artificial intelligence stocks with impressive POWR Ratings. So, you may consider these 3 B-rated (Buy) stocks instead:
Oracle Corporation (ORCL)
International Business Machines Corporation (IBM)
Synopsys, Inc. (SNPS)
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AI shares were trading at $21.72 per share on Wednesday afternoon, up $0.09 (+0.42%). Year-to-date, AI has gained 94.10%, versus a 4.51% rise in the benchmark S&P 500 index during the same period.
About the Author: Santanu Roy
Having been fascinated by the traditional and evolving factors that affect investment decisions, Santanu decided to pursue a career as an investment analyst. Prior to his switch to investment research, he was a process associate at Cognizant. With a master's degree in business administration and a fundamental approach to analyzing businesses, he aims to help retail investors identify the best long-term investment opportunities.
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