2023-10-19 05:29:48 ET
Summary
- Vertiv Holdings' stock price has risen over 210% year-to-date due to strong demand for data center capacity.
- However, the risk-reward for Vertiv is no longer favorable in the next 6-12 months after the significant run-up in its stock price.
- VRT stock now trades at an elevated earnings multiple as compared to its historical average, leaving little room for error and increasing the risk of a re-rating.
Vertiv Holdings ( VRT ) has been one of the hottest industrial stocks of 2023, with its share price up over 210% year-to-date. The data center infrastructure provider is benefiting from strong secular tailwinds, as demand for data center capacity continues to grow at a healthy clip. However, after the huge run-up in its stock price, I believe high expectations and downside surprise risks no longer make Vertiv favorable over the next 6-12 months. Investors are better off staying on the sidelines for now.
Investment Thesis
Vertiv operates in an attractive market, providing critical products and services to data centers and telecom companies. Growth is being driven by several trends, including cloud computing, AI/machine learning, 5G rollout, and digitalization across industries. The company is differentiated by its breadth of offerings, which include power management, thermal management, integrated rack systems, and software/services solutions. Vertiv has also strengthened its operational execution and is demonstrating improved profitability.
However, the stock now trades at a very high ~33x P/E multiple on TTM earnings, versus sector median of under 16x. While the long-term prospects remain bright, risks have increased for Vertiv in the near term. Any execution stumbles or slowdown in demand could easily lead to a re-rating of the stock. After the 210% run-up in share price year-to-date, it is prudent for investors to wait on the sidelines until a better entry point emerges. I rate Vertiv a Hold.
Company Overview and Competitive Edge
Vertiv provides critical digital infrastructure and continuity solutions primarily for data centers, communication networks, and commercial/industrial environments. Its key offerings include power management, thermal management, integrated rack systems, and services.
In power management, Vertiv offers a broad range of AC and DC power systems, uninterruptible power supplies, switchgear, busway products, and power distribution units. This diverse power portfolio enables Vertiv to meet the varied needs of customers for reliable and efficient power infrastructure.
Vertiv's thermal management portfolio includes a wide variety of air and liquid cooling systems such as air handlers, chillers, cooling towers, rack cooling, row cooling, and direct-to-chip liquid cooling. With this breadth of cooling technologies, Vertiv can effectively address customer needs across a range of power densities and cooling requirements.
For integrated rack systems, Vertiv provides integrated racks, power distribution, and software for managing IT equipment within racks. This includes configurable rack-based solutions that seamlessly integrate power, cooling, and IT infrastructure management.
Vertiv also offers extensive services capabilities encompassing design, installation, maintenance, monitoring, and other technical services for data center infrastructure. Vertiv assists customers throughout the full lifecycle of their critical infrastructure assets.
Vertiv has a competitive edge in the data center market for several reasons. Firstly, it has a diverse product portfolio spanning power, thermal, rack, and software modalities. This comprehensive offering combined with services expertise allows Vertiv to serve customer needs in a holistic manner.
Secondly, Vertiv has a global services network with over 200 service centers and 3,500+ engineers providing maintenance, monitoring and technical support. This high-touch service fosters customer loyalty and stickiness.
Thirdly, the company enjoys long-standing customer relationships across industry verticals, spanning decades in some cases, based on consistent reliability and performance.
Moreover, Vertiv can provide complete turnkey solutions for data center infrastructure encompassing design, products across categories, and ongoing services over the operating life.
Additionally, Vertiv possesses deep domain expertise in data center infrastructure and the ability to address complex customer requirements. As CEO Giordano Albertazzi explained, "Vertiv differentiates through our new products, our global services network, our system view and our advanced control systems."
Significant Rerating Risks at These Elevated Levels
At current elevated valuation levels, Vertiv faces significant downside risks that should give prudent investors pause. Firstly, major hyperscale/cloud companies like Amazon and Microsoft are key customers for Vertiv, accounting for a substantial portion of revenue. Any cutbacks or delays by these customers in their data center capacity expansion plans would directly hurt Vertiv's growth trajectory.
Secondly, Vertiv is still in the process of strengthening its internal processes and operational rigor after years of uneven execution. Any stumbles or backslides on this front or integration challenges with recent acquisitions could negatively impact the company's financial performance in the coming quarters. Investors should watch for any signs of weakness.
Thirdly, with its sky-high P/E multiple near 50x based on 2023 earnings estimates, Vertiv stock leaves very little room for error. The company has essentially zero margin baked in for any negative surprises, whether in terms of demand softness or earnings shortfalls. Any minor issues could easily lead to a sharp sell-off, as the market re-rates Vertiv's valuation multiples lower.
In terms of valuation, Vertiv stock currently trades at an extremely elevated P/E of approximately 25x based on 2023 EPS projections. The rich current valuation essentially implies flawless execution on Vertiv's part along with sustained favorable demand trends over the next 12-18 months.
However, downside risks have clearly increased for Vertiv, including uncertainty around data center infrastructure demand and rising competitive threats in a hot market. While upside potential still exists from growing AI/high density cooling demand, much of this positive impact already appears fully priced into Vertiv stock after its meteoric 210% rise year-to-date.
As Executive Chairman Dave Cote astutely noted on the recent earnings call: "There are direct winners of AI technology such as companies that develop generative AI tools, and then there are companies that work on the infrastructure side of AI." While Vertiv firmly resides in the attractive latter infrastructure category, its stock price seems to have sprinted way ahead of itself in terms of pricing in the potential upside from the AI trend.
In summary, I believe Vertiv stock could be vulnerable to a sharp pullback based on any negative headlines that fall even slightly short of the elevated expectations baked into the current valuation. Prudent investors focused on risk management should likely await a better entry point that prices in an appropriate margin of safety. I rate Vertiv stock a Hold at current levels.
For further details see:
Vertiv Holdings: Excellent Business But Little Margin Of Safety