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SUMMARY
Parkev Tatevosian, CFA, analyzes Applied Digital's recent financial performance, highlighting a significant revenue increase and a sharp decline in share price. He discusses the company's improved profitability metrics, long-term contracts with major hyperscalers, and evaluates the risk-reward profile, ultimately upgrading the stock to a buy recommendation.
MAIN POINTS
- Applied Digital reported $259 million in quarterly revenue, a 47% year-over-year increase, with total contracted value for long-term leases at $36 billion.
- Despite a steep share price drop from over $50 to below $25, the stock remains up over 16% year-to-date, and recent revenue growth has been driven by demand from hyperscalers.
- Applied Digital secures contracts with major hyperscalers, enabling favorable borrowing terms, while profit margins remain negative but are improving.
- Returns on invested capital have improved from -120% in 2020 to -4.6%, and the stock's forward price-to-sales ratio is at a historical low of 4.3.
- A revised discounted cash flow analysis yields an intrinsic value of over $42 per share, indicating a 48% upside from the current market price.
- The main risk is potential overbuilding of data center capacity and uncertainty about contract renewals with hyperscalers after current agreements expire.
DETAILED ANALYSIS
Applied Digital has demonstrated remarkable revenue growth, reporting $259 million in its latest quarter, representing a 47% increase from the prior year. The company has secured long-term lease contracts valued at approximately $36 billion, a substantial figure relative to its current revenue base. Despite these strong fundamentals, the stock experienced a significant decline, falling from over $50 to below $25 per share in recent months.
This correction followed earlier warnings about excessive valuation, but the subsequent drop has created a more attractive entry point for investors.
The company's revenue surge is largely attributed to increased demand from hyperscale clients such as Microsoft, Amazon, Alphabet, and Meta Platforms. These partnerships not only drive top-line growth but also enhance Applied Digital's ability to secure favorable financing terms, as lenders are reassured by the creditworthiness of these clients. Although profit margins remain negative at around -30% on a trailing twelve-month basis, there has been notable improvement as the company scales its operations.
Returns on invested capital have also improved significantly, rising from -120% in 2020 to -4.6% currently, reflecting better capital allocation and operational efficiency.
Valuation metrics have become more compelling following the share price decline. The forward price-to-sales ratio now stands at 4.3, near its historical lows. A revised discounted cash flow analysis estimates the intrinsic value per share at over $42, suggesting a potential upside of approximately 48% from current levels.
However, a key risk remains: the possibility of overbuilding data center capacity. While current contracts span three to ten years, there is uncertainty regarding whether hyperscalers will renew these agreements once they expire, especially if internal capacity becomes sufficient. Despite this risk, the improved valuation and operational metrics lead to an upgraded buy recommendation for Applied Digital.
LINKS
- Channel membership for early access, spreadsheets, and private Discord community.
- Special Motley Fool Stock Advisor offer.
- Parkev Tatevosian's book on evaluating publicly traded companies.
- Fiscal.ai investment research platform with viewer discount.
- Webull investing platform with bonus shares offer.
- Free monthly newsletter via Substack.