Artificial intelligence (AI) is arguably the most important theme for Wall Street in 2023 and enterprise software companies. C3.ai (AI -5.90%) Benefited greatly from that extra attention. The stock has surged more than 200% since his January, but has recovered somewhat in recent weeks.
Will this AI stock take a breather and then surge, or will the hype bubble finally burst? You must consider these three potential concerns.
1. C3.ai has slow revenue growth
C3.ai sells AI applications and software to enterprises. This includes a platform where developers can use his C3.ai building blocks to create his AI applications, or buy finished applications that serve specific business purposes.
For example, C3.ai offers law enforcement applications that can use data and AI to uncover patterns and trends. Energy companies can use C3.ai’s suite of oil and gas apps to optimize forecasting and scheduling, comply with regulations, and identify operational risks. In other words, AI is helping people work smarter with their data.
Rapid growth might be expected for companies with innovative solutions like AI, but the numbers don’t seem to show it. As the chart below shows, C3.ai’s quarterly revenue growth hasn’t exceeded 42% and has slowed in recent quarters.
One of the reasons for the recent decline is that the company switched to a consumption-based billing model. Management expects growth to accelerate over time as customers use its technology more. On the other hand, if previous sales efforts have been successful, why would C3.ai make such a change?
AI Revenue (Quarterly YoY Growth) Data by YCharts
If anything, the stock market rally should follow rather than precede improved growth. Investors appear to be giving management credit for results yet to come. This means disappointing earnings numbers could hit stocks hard going forward.
2. C3.ai’s Profit Margin Reversal
Growing companies often suffer losses and strive for profitability because revenue growth exceeds costs. This is called operating leverage and it bodes well for the future of the company. However, C3.ai’s losses have not yet diminished. Its operating margin continues to deteriorate.
AI Operating Margin (TTM) Data by YCharts
Management believes it will achieve non-GAAP (generally accepted accounting principles) operating income five quarters from now, but that does not take into account significant expenses such as stock-based compensation. It could take at least two years for the company to become profitable. That is, if things go according to plan. This is noteworthy, especially given weak revenue growth.
3. C3.ai has customer concentration risk
C3.ai doesn’t have a large customer base, just 236 as of January 31st. For example, a company counts: individual departments, departments, business units or groups This may overstate the number of distinct companies with which C3.ai does business.
One customer entity accounted for 45% of revenue in the quarter ending January 31st. Two separate customer entities accounted for 36% and 10% of C3.ai’s revenue in the year-ago quarter. In other words, a handful of companies water most of his C3.ai customer base.
What if any of these entities are like baker fuse (its biggest customer), pulling that business? The company may lose not just one customer (as defined by C3.ai), but multiple customers.
This is a speculative stock
These are some factors to consider when considering C3.ai as a potential investment. The business isn’t growing (or making a profit) much right now, and losing the wrong customer can be a big setback. That makes stocks more speculative and taking risks is not a good idea. Investors should probably avoid investing until they see several quarters of improved growth and improved margins.
