Is C3.ai Stock a Buy Now?

C3.ai (AI 1.98%) posted its third-quarter earnings report on March 2. The artificial intelligence (AI) software company's revenue rose 42% year-over-year to $69.8 million, beating analysts' estimates by $2.6 million. Its adjusted net loss narrowed from $10.3 million to $7.7 million, or $0.07 per share, which also surpassed analysts' expectations by $0.19.

C3.ai's stock rose 3% the following day, even as concerns about the Russian-Ukrainian war, inflation, and surging oil prices weighed down the broader market. However, the stock remains nearly 50% below its IPO price and almost 90% below its all-time high. Should investors consider accumulating some shares of C3.ai after its latest earnings beat?

Image source: Getty Images.

How fast is C3.ai growing?

C3.ai's AI algorithms can be plugged into a company's existing software infrastructure to optimize supply chain operations, improve employee safety, streamline spending, detect fraud, and more. It also provides its AI services as pre-built stand-alone applications.

C3.ai primarily serves large energy, industrial, and government customers. Its largest customer is the oil field services giant Baker Hughes (BKR -1.41%), which accounted for 39% of its revenue in the first nine months of fiscal 2022. Its current contract with Baker Hughes will last until fiscal 2025.

As for the rest of its customer base, C3.ai ended the third quarter with 50 "customer-entities" (entire organizations) and 218 unique customers (distinct divisions across those organizations), compared to 39 customer-entities and 120 unique customers in the prior year quarter.

C3.ai grew like a weed in fiscal 2020 (which ended in April of the calendar year), but it lost its momentum in fiscal 2021 as the COVID-19 pandemic spread and disrupted the energy and industrial sectors. However, its growth accelerated over the past year as those headwinds faded:

Data source: C3.ai. YOY = Year-over-year.

C3.ai now expects its revenue to rise 38% for the full year, compared to its previous guidance for 35%-36% growth. Analysts expect its revenue to rise 31% in fiscal 2023. Based on those expectations, C3.ai's stock looks reasonably valued at less than eight times next year's sales.

For reference, Palantir (PLTR 3.69%), the data mining firm that believes it can generate at least 30% annual revenue growth through 2025, trades at 12 times this year's sales and nine times next year's sales.

Expanding gross margins and stabilizing losses

C3.ai remains unprofitable by both generally accepted accounting principles (GAAP) and non-GAAP measures. However, its non-GAAP gross margins have continuously expanded over the past year:

Data source: C3.ai.

Those margins are in line with those of comparable industry peers like Palantir, which reported a non-GAAP gross margin of 83% in its latest quarter.

C3.ai attributes its ongoing gross margin expansion to the growth of its higher-margin subscription business and its improving scale. Those expanding margins also suggest that C3.ai has plenty of pricing power in its niche market for integrated AI algorithms and applications.

C3.ai's net loss widened by both GAAP and non-GAAP measured in the first nine months of 2022, but it narrowed both sequentially and year-over-year in the third quarter. Its costs previously spiked after it reorganized its sales teams into an independent unit to pursue big deals last July, but that decision was costly and ineffective. It reversed that decision in the second quarter, and that move seems to be stabilizing its net losses.

C3.ai still expects its non-GAAP operating loss to widen -- from $37.5 million in fiscal 2021 to $90-$94 million in fiscal 2022 -- as it it ramps up its investments and attempts to expand its customer base.

However, it also ended the third quarter with $1.02 billion in cash, cash equivalents, and short-term investments, so it can easily afford to rack up more losses as it expands. Its low debt-to-equity ratio of 0.16 also gives it plenty of room to take on additional leverage.

Still a speculative play with lots of upside potential

C3.ai isn't a stock for queasy investors. Its customer concentration issues are still worrisome, it lacks a clear path toward profitability, and it could be disrupted by similar AI services from larger cloud service providers.

That said, the stock's low price-to-sales ratio could limit its downside potential as it gradually expands. Its low enterprise value of $1.3 billion could also make it a tempting takeover target for a bigger tech company.

In short, I think C3.ai is worth nibbling on at these levels. I was not a fan of this stock when its valuations hit irrational nosebleed levels in late 2020, but the risk-reward ratio now looks much more compelling.