Determine whether this enterprise software firm is a genuine competitor or a pretender in the thriving AI industry.
Artificial intelligence (AI) is undoubtedly one of the most significant themes on Wall Street in 2023, with enterprise software company C3.ai (NYSE: AI) reaping the rewards of this increased focus. Share prices have surged over 200% since January but have experienced a decline in recent weeks.
Is this AI stock merely pausing before resuming its upward trajectory, or is it a hype-driven bubble about to burst? Before investing during this dip, long-term investors should weigh these three potential concerns that C3.ai’s business must tackle to succeed.
C3.Ai’s Lacklustre Revenue Growth
C3.ai provides AI applications and software to enterprises, including a platform that allows developers to create AI applications using C3.ai’s components or purchase pre-built applications tailored for specific business needs.
For instance, C3.ai offers a law enforcement application that employs data and AI to reveal patterns or trends. Energy companies can utilize C3.ai’s Oil and Gas suite of apps to enhance forecasting and scheduling, adhere to regulations, and pinpoint operational risks. In essence, AI enables users to harness data for smarter operations.
One would anticipate rapid growth from a company offering innovative AI solutions, but the figures tell a different story. As the chart below demonstrates, C3.ai’s quarterly revenue growth has remained at 42% and has decelerated in recent quarters.
A contributing factor to this decline is the company’s transition to a consumption-based billing method. Management anticipates growth to rise over time as customers increase their use of its technology. However, why would C3.ai implement this change if previous sales efforts were successful?
Ideally, the stock’s soaring share price should follow, not precede, improved growth. Investors are crediting management for outcomes that have not yet materialized, implying that any disappointing earnings results in the future could significantly impact share prices.
C3.Ai’s Profit Margins Are Regressing
Expanding companies often incur losses and strive for profitability as revenue growth outpaces expenses. This phenomenon, known as operating leverage, is an excellent indicator of a company’s prospects. Nevertheless, C3.ai has yet to reduce its losses as its operating margin deteriorates.
Management projects the business will achieve a non-GAAP (generally accepted accounting principles) operating profit in five quarters; however, this projection omits critical expenses such as stock-based compensation. The company might be at least two years away from profitability – if everything goes as planned. This issue merits attention, particularly given the weak revenue growth.
C3.AI Faces Customer Concentration Risks
C3.ai has a limited customer base, with only 236 customers as of Jan. 31. This number includes some peculiarities: the company considers each unique division, department, business unit, or group within a customer entity as a separate customer, potentially inflating the count of distinct enterprises with which C3.ai does business.
A single customer entity represented 45% of revenue in the quarter ending Jan. 31. In the same quarter of the previous year, two separate customer entities contributed 36% and 10% of C3.ai’s revenue. In other words, a handful of enterprises generate most of C3.ai’s customer base revenue.
What would occur if one of these entities, such as Baker Hughes (its largest customer), were to withdraw its business? C3.ai could potentially lose multiple customers (by its definition), not just one.
A Speculative Stock to Consider
These factors should be considered when evaluating C3.ai as a potential investment. The company is currently experiencing minimal growth (and is yet to be profitable), and losing a key customer could lead to a significant setback. This makes the stock more speculative, and there may be better choices than pursuing risky investments. Investors should likely exercise caution and wait for several quarters of improved growth and better margins before committing to C3.ai.
While the AI space holds excellent promise, C3.ai’s current growth, profitability, and customer concentration risks make it a speculative investment. As a result, investors should exercise caution and monitor the company’s performance over the next few quarters before making any decisions. For those looking to invest in the AI industry, consider exploring alternative options with stronger financials and a more diverse customer base to minimize potential risks.
