Shares of C3.ai (AI 3.02%) have set the market on fire in 2023, with outstanding gains of about 180% as of this writing. But the pure-play artificial intelligence (AI) enterprise software company has lost steam of late.
The stock has slipped in the past month, which seems surprising as there has been no company-specific news that should have led to the drop. Of course, there has been chatter on Wall Street comparing the eye-popping surge in AI stocks to a bubble about to pop, and so this may have negatively impacted the stock.
But C3.ai stock is now available at a relatively cheap valuation. Should investors consider taking advantage of its pullback and buy this AI stock? Let's find out.
Cheaper than before, but is it cheap enough?
C3.ai currently trades at a price-to-sales ratio of 13. That's well below its sales multiple of over 16 a month ago.
AI PS Ratio data by YCharts
However, it is worth noting that C3.ai was trading at just 4.4 times sales at the end of 2022. The stock's massive surge in 2023 explains why it is trading at such a rich valuation despite a significant pullback in the past month. Also, C3.ai's hot rally this year is driven more by the hype in AI applications rather than its own financial performance. This is evident from the following chart.
AI Revenue (TTM) data by YCharts
C3.ai's top line has remained stagnant over the past couple of quarters, while the stock has simply taken off. The company's poor top-line performance can be attributed to its strategy of changing the business model from a subscription-based one to a consumption-based one. A subscription-based model gave C3.ai long-term revenue visibility since it was able to tie up customers in long-term contracts.
A usage-based model, on the other hand, means that the company will get paid only when clients use its services. There are a couple of downsides to this model. First, customers can cut down on spending during difficult times. Second, C3.ai won't be able to build a long-term revenue pipeline by tying down customers to subscription contracts.
But the upside is that its solutions become more accessible, as customers won't have to enter into contract negotiations. This explains why C3.ai has seen a significant uptick in the number of customer agreements of late, and has witnessed a reduction in the average sales cycle with respect to signing new deals.
C3.ai CEO Tom Siebel explained the impact of the business model change on the company's June earnings conference call:
In Q4, we closed 43 agreements, including 19 pilots that were initiated in the quarter. The number of qualified enterprise opportunities targeted for closure within 12 months in our sales pipeline has increased by more than 100% in the past year. During fiscal year '23, we closed 126 agreements, up from 83% in the prior year.
He added that the average sales cycle also fell to 3.7 months from five months in the year-ago period.
It has been four quarters since C3.ai made the business model switch, and the company anticipates that it will take another three quarters before the change makes a material impact on its performance. C3.ai recently completed the first quarter of its fiscal 2024 (which ended on July 31). So investors can expect a material improvement in the company's business starting at the end of the current fiscal year.
Not surprisingly, the company forecasts a 15% increase in fiscal 2024 revenue to $307.5 million at the midpoint of its guidance range. That would be a nice improvement over its revenue growth of just 5% in fiscal 2023. More importantly, C3.ai's revenue is expected to grow at a faster pace from fiscal 2025, as the following chart shows.
AI Revenue Estimates for Current Fiscal Year data by YCharts
What should investors do?
There is no doubt that C3.ai remains expensive considering its current pace of growth. But its growth is expected to pick up sharply, as the discussion above indicates. What's more, analysts are anticipating C3.ai's earnings to increase at a compound annual rate of almost 51% for the next five years. The company seems capable of delivering such impressive growth as it is sitting on a massive addressable market worth $791 billion.
So investors who don't mind paying a rich multiple for C3.ai's future prospects might want to consider taking advantage of its recent pullback since a gradual improvement in its pace of growth is likely to boost Wall Street's confidence in this AI stock and send it higher in the long run.
