Applied Digital's Stock Recovery: Analysts Forecast Strong Upside

Key Points

• Applied Digital has transitioned from crypto mining to a more AI-focused high-performance computing business.
• Analysts see a 110% upside in the stock.
• Soaring energy expenses hurt Applied Digital's margins and profitability last quarter.

Applied Digital NASDAQ: APLD is a high-performance computing (HPC) stock that investors should be aware of. Since going public in April 2022, the company has been a horrid investment. Shares are down 56% since then.

However, the average price target from Wall Street analysts who updated their forecasts after the firm’s Aug. 28 earnings release shows a bullish sentiment. Based on the company’s current stock price, the average updated price target implies an upside of 110%.

Let's break down what this technology company does and how the shares might perform going forward. We’ll do this by diving into the history of the firm and its current annual report. I’ll also review the company’s recent earnings report.

Applied Digital’s Strategic Shift: Crypto to AI

The company designs, builds, and operates data centers. Its business is based on hosting, where it leases out processing capacity in its data centers. Customers buy these hosting resources so that they can take advantage of high-performance computing without having to build their own data centers.

Applied Digital became well-known for its place within the cryptocurrency mining market. In fact, the company initially went public under the name Applied Blockchain.

Blockchain forms the basis of cryptocurrencies. When people send each other cryptocurrency, transactions get grouped together in "blocks." To verify that these transactions are legitimate, “miners” must compete to solve a complex mathematical problem. This difficult requirement ensures that the record of transactions cannot be easily tampered with. The miner who solves the problem is rewarded with cryptocurrency as compensation for their efforts.

Mining can be very profitable if cryptocurrencies are worth a lot of money. However, because the mathematical problems are so complex, they require HPC to solve. This is where Applied Blockchain stepped in.

However, by November 2022, the company changed its name to Applied Digital. This was due to horrible performance and the need to shift away from its cryptocurrency focus. Shares were down 76% since the IPO, driven largely by declining cryptocurrency prices. Bitcoin was down 58% over the same period.

Now, the firm offers a more diverse range of HPC hosting services for AI tasks like natural language processing and machine learning. HPC can be accessed through the cloud or through leasing physical processing space in the firm’s data centers. It also still offers hosting services for crypto miners like Marathon Digital NASDAQ: MARA.

Energy Costs Plague Margins in Fiscal Q4

In the past quarter, revenue saw a large increase, but so did losses. This caused the company to beat analysts' estimates on revenue and fall short of estimates on earnings. It posted an adjusted loss of $0.36 per share, down from no earnings a year ago and a 12-cent larger loss than the previous quarter. Analysts expected a loss of $0.22 per share.

Revenue was $47.3 million, an increase of nearly 100% from a year ago but essentially unchanged from the prior quarter. Analysts expected revenue of $39.1 million.

One item in the earnings report that really stands out is the company’s gross margin, which was negative for the second straight quarter. The prior quarter marked the first time the gross margin was negative in the company’s history.

It attributed this to higher energy costs used to generate its hosting revenues. Depreciation, amortization, and personnel costs also played a part. This means that the cost of the electricity to run the servers was close to, if not higher than, the amount of revenue that running the servers actually brought in. This is not a good sign.

On the positive side, the company has executed a letter of intent (LOI) agreement with a U.S. hyperscaler customer to provide 400 MW of capacity for its cloud business. However, this wasn’t new information and thus didn’t help the share price. It’s important to note that LOIs are generally non-binding, meaning this customer could easily back out of the deal. Shares fell 10% in after-hours trading.

Uncertainty Around Energy Prices Is Worrisome

Applied Digital's currently negative gross margin may be temporary, due to unusually high electricity prices in regions where its data centers are located. However, it’s difficult to parse out that claim with available data. The company didn’t provide any information on whether it expects lower energy prices going forward.

Even if temporary, the fact that margins are low enough that this is even an issue is unsettling. It’s hard to see shares going on the upswing when the company is unprofitable before you’ve even looked halfway down its income statement.