2023-08-02 15:59:14 ET
Summary
- Earnings season has been strong, with the S&P 500 EPS beat rate near 80% and improved earnings reactions.
- Vertiv Holdings reported impressive Q2 earnings, beating expectations and showing strong growth in revenue and operating margin.
- The company's operating margin jumped amid strong pricing power while current-year free cash flow guidance was leaps and bounds above the previous estimate.
- VRT's valuation is fair, but a pullback to the upper $20s may present a buying opportunity.
Earnings season has been robust so far. The S&P 500 EPS beat rate is near 80%, above the 5-year average, according to FactSet , while earnings reactions have improved after a sluggish start. But with a renewed sense of uneasiness about the state of the economy after Fitch’s downgrade of US debt, an August equity market retreat could be in the cards during this pre-election year. Cyclically exposed firms may be particularly vulnerable to a correction. But can AI save the day?
I am downgrading shares of Vertiv Holdings ( VRT ) based on valuation and stretched technicals after its earnings blowout and monster price reaction.
80% S&P 500 EPS Beat Rate, AI Fuels Optimism
FactSet
According to Bank of America Global Research, VRT is an electrical product manufacturer focused on data centers (70% of revenue) and telecom (20%) end markets. In 2022, Vertiv generated $5.7bn in revenue. Key product offerings include power & thermal management, IT management, and related services.
The Ohio-based $10.1 billion market cap Electrical Components and Equipment industry company within the Industrial sector trades at a high 85 trailing 12-month GAAP price-to-earnings ratio and pays a low 0.04% dividend yield. Post earnings today, shares trade with a much lower but still elevated 49% implied volatility percentage and the short interest is low at just 2.6% of the float.
VRT easily topped analysts’ earnings expectations on August 2. The firm reported Q2 operating EPS of $0.46, above the $0.29 consensus. Revenue, meanwhile, was up 24% year-on-year to $1.7 billion, a huge $110 million beat with organic net sales growth of 25%.
What I found stunning was its adjusted operating margin of 14.5% - up 860 basis points from the same quarter a year ago. The management team issued upside guidance, including current-year free cash flow of $550 million (midpoint) versus $350 million (midpoint) compared to previous guidance. It now expects about $1.60 of EPS in 2023.
With trailing 12-month FCF that is now near its pre-COVID peak and solid operating leverage, there is a lot to like from the quant side here. Fundamentally, Vertiv’s AI adoption should lead to demand for data center GPUs – those require added electricity load and draw more heat compared to CPUs, a significant boon to VRT. This is a trend to watch in 2024 and beyond.
For now, we just have the company’s guidance to go from. Real bucks are seen in much stronger free cash flow, though. Despite a capacity-constrained market, Vertiv demonstrated its power by raising prices nearly 10% last quarter and then seeing that flow through to margins. Downside risks continue to include reduced demand for company-owned data centers, poor execution on cost-savings plans, and increasing industry competition.
On valuation , analysts at BofA see earnings nearly tripling this year after dipping to $0.53 in its FY 2022. Out-year EPS is seen growing at a solid clip of 13% before some deceleration takes place by 2025. Dividends, meanwhile, are expected to be nil after a one-penny payout both in 2021 and last year. Given the jump in per-share earnings, its P/E ratios actually turn reasonable on a forward basis.
What’s more, Vertiv’s EV/EBITDA ratio is simply near the market’s average at 14.8 currently, per Seeking Alpha. Finally, as mentioned before, free cash flow is impressive for such a fast grower. Profitability is decent and there has been a slew of upward EPS revisions since I initiated coverage of this Industrial-sector name late last year, though the pace of said revisions appears to have been slowing. More estimate upgrades are likely following the strong Q2 results, though, in my view.
Vertiv: Earnings, Valuation, Dividend, Free Cash Flow Yield Forecasts
BofA Global Research
If we assume long-term earnings growth of 9%, then the stock’s 21 forward operating P/E yields a PEG of 2.3 - close to the S&P 500’s average. Moreover, Vertiv’s earnings multiple is awfully close to its 5-year average. Now, let’s assume EPS of $1.75 over the next 12 months, if we apply a low 20s P/E to that, then we are talking about a stock that should be priced in the mid-$30s, making it a hold on valuation today. I would say there is an upside risk to my multiple assumptions if the company continues to grow its margins.
VRT: High Growth Warrants A Premium Valuation Vs Industrials
Seeking Alpha
Versus its competitors , VRT has a comparable P/E both for 2023 and looking out to 2024 and 2025. A bullish factor is its low 1.65 trailing price-to-sales ratio compared to firms like Generac, Regal Rexnord Corporation, nVent Electric plc, Plug Power Inc, and Sensata Technologies Holding plc.
Peer Comparison: Major Alpha YoY
Seeking Alpha
Looking ahead, corporate event data provided by Wall Street Horizon show a projected Q3 2023 earnings date of Wednesday, October 25. It then hosts an investor conference in late November which could also strike up some share price volatility.
Corporate Event Risk Calendar
Wall Street Horizon
The Technical Take
With a fair valuation and being arguably cheap compared to some of its peers, VRT’s chart is what the bulls want to see. There is no overhead supply stopping it from running higher. Of course, momentum cannot last forever, so keeping an eye out for buying opportunities on pullbacks may be the right course of action. I see interesting tells from a trio of price gaps – two of which related to earnings events. Notice in the chart below that the first happened after its Q1 report back in April. Then some management changes in May helped lift the stock. Finally, today’s earnings reaction took VRT to all-time highs.
This has the hallmarks of a breakaway gap (April) followed by two runaway gaps. Given extreme RSI readings, being ready to buy on a retreat to $27 would be prudent and would represent a good buy on valuation. I must acknowledge, though, that shares holding near the high of the day this afternoon is impressive in a lousy tape, so you might not get that opportunity. At the very least, apply the “3-day rule” with this one – given the major earnings-related gap, waiting a few sessions for the dust to settle is wise.
VRT: Major Earnings-Related Price Gap Sends the Stock To ATHs
Stockcharts.com
The Bottom Line
I have a hold rating on VRT. The valuation looks fair to me given the strong earnings growth, while a price thrust today has baked in much near-term optimism. Buying on a pullback to the upper $20s makes sense both via the chart and with where I see fair value.
For further details see:
Vertiv: An AI Beneficiary, Margins & Free Cash Flow Soar In Q2