Is C3.ai Stock a Buy Now?

C3.ai's (AI 3.02%) stock dropped 8% during after-hours trading on Dec. 6 after the artificial intelligence (AI) software company posted its latest earnings report. For the second quarter of fiscal 2024, which ended on Oct. 31, its revenue rose 17% year over year to $73.2 million but missed analysts' estimates by $1.1 million.

Its adjusted net loss widened from $11.8 million to $15.3 million, or $0.13 per share, but cleared the consensus forecast by a nickel. On a generally accepted accounting principles (GAAP) basis, its net loss widened from $68.9 million to $69.8 million. 

Image source: Getty Images.

Those mixed headline numbers didn't impress the bulls, and C3's stock remains 36% below its initial public offering (IPO) price from three years ago. Should contrarian investors buy C3 as a turnaround play today, or should they stick with more promising AI stocks?

Understanding C3's core business

C3.ai develops AI algorithms that can be plugged into a company's existing software infrastructure to accelerate, automate, and optimize certain tasks. It mainly serves large customers in the energy, industrial, aerospace, and government sectors.

The company generates most of its revenue from subscriptions, but it started offering usage-based options over the past year to attract more customers in the tougher macro environment. It also notably generates about 30% of its annual revenue from a joint venture with the energy giant Baker Hughes, which is set to expire in fiscal 2025. As the following chart illustrates, C3's cost of revenue continues rising at a much faster rate than its actual revenue.

Data source: C3.ai.

C3's revenue only grew 6% in fiscal 2023 (which ended on April 30), compared to its 38% growth in fiscal 2022 and 17% growth in fiscal 2021, as the macro headwinds drove companies to rein in their software spending. It also faces stiff competition from robotic automation companies like UiPath, AI-powered analytics companies like Palantir Technologies, and Salesforce's AI and automation services.

Another quarter of uneven growth and shrinking margins

On the bright side, C3's revenue growth accelerated over the past three quarters as the market's interest in AI applications grew and the macro environment gradually stabilized. Unfortunately, its remaining performance obligations (RPO, or the remaining value of its existing contracts that have yet to be recognized as revenue) still declined year over year for six consecutive quarters as its adjusted gross margin shrank.

Data source: C3.ai. YOY = Year over year. *GAAP.

C3 expects its revenue to rise 11% to 17% year over year in the third quarter and grow 11% to 20% for the full year. Analysts expect its revenue to rise 15% this year and 20% in fiscal 2025. Based on those expectations and C3's enterprise value of $2.5 billion, its stock seems reasonably valued at 7 times next year's sales.

For reference, UiPath and Palantir, which are both growing at a similar rate as C3, trade at 8 and 13 times next year's sales, respectively. Salesforce, which is growing a lot slower than all three companies, trades at 6 times next year's sales.

A murky future with a lot of red ink

But there's a key difference: All three companies are profitable by non-GAAP (adjusted) measures. C3 originally aimed to turn profitable on a non-GAAP basis by the end of fiscal 2024, but it withdrew that guidance in the first quarter because it wanted to ramp up its research and development (R&D) and marketing spending for its new C3 Generative AI Suite, which provides dozens of generative AI tools for various industries. That might seem like the right play given the soaring interest in generative AI platforms over the past year, but C3 could also be desperately trying to rebrand its business again -- as it did in its previous iterations as C3 Energy and C3 IoT (Internet of Things) -- to stay relevant in the rapidly evolving AI market.

C3's management mentioned "generative AI" dozens of times during its conference call, but there's no guarantee that stand-alone generative AI platforms like OpenAI's ChatGPT won't eventually render C3's tools obsolete. Moreover, if C3 fails to renew its deal with Baker Hughes, that abrupt loss of revenue would more than offset any gains from its generative AI tools.

C3's declining RPO and gross margin also indicate it doesn't have much pricing power in the crowded AI market. Unless those key metrics improve, it will continue burning cash and remain deeply unprofitable.

It's not the right AI stock to buy right now

C3 has a catchy ticker, but there are plenty of better AI stocks to buy right now. Without making any meaningful progress toward resolving its customer concentration issues, expanding its gross margin, or narrowing its losses, C3 will continue to trade at a steep discount to its IPO price and underperform the broader market.