2023-12-27 09:04:31 ET
Summary
- Vertiv is a leading global provider of products and services for data centers, benefiting from the growth in AI.
- The company has shown strong organic growth and is leveraging investments to boost margins.
- While Vertiv's stock has seen notable growth, the current valuations are high, and waiting for a better entry point is advised.
Data centers represent a rapidly growing sector fueled by the explosive growth in AI, and Vertiv ( VRT ) stands out as a top global provider to these facilities. Vertiv, which was formerly called Emerson Network Power, has a product range that spans power, cooling, monitoring, and control, complemented by an extensive service network. Since 2017, Vertiv has shown enhanced organic growth through strategic market approaches, poised for continued market share expansion. They're also in the early stages of leveraging investments to boost margins, targeting 16% in the midterm and aiming for 20% in the long run. Concurrently, their free cash flow and balance sheet strength are on the rise. While Vertiv's stock has seen notable growth due to improved execution and a promising outlook—fueled by AI optimism, resulting in positive earnings projections—the current valuations seem a bit high. Waiting for an opportune entry point is advised, when balancing the company's strong prospects against the stretched valuation levels.
Recent Investor Day Provided Clarity
Vertiv recently hosted an investor day, which provided extensive detail and clarity around the company's strategy. Before the event, the company adjusted its 2023 forecast upwards due to robust market demand for its essential digital infrastructure products and services. Vertiv now anticipates sales to range between $6.875 billion and $6.895 billion, compared to the previous estimate of $6.826 billion to $6.850 billion. The increase in expected revenue appears to stem from higher sales volume, as there were no changes in price guidance. The projected profit increase aligns with the company's consistent low 30s volume growth seen throughout the year. Management reiterated their remarks about orders, indicating a year-on-year increase of over 10% from the previous fourth-quarter figures, boasting a book-to-bill ratio of 1.1x and ongoing growth in their backlog.
Management provided an initial outlook for 2024 at their investor day. VRT projections include anticipated organic sales growth ranging between 8-10%, aiming for operating margins of 16.5-16.9% (compared to the consensus of 17%), and an adjusted free cash flow conversion rate of 83-87%, which was also slightly below street consensus. The expected decrease in free cash flow conversion for 2024 is influenced by a ~15% one-time benefit realized in 2023 from the introduction of the advanced customer payment program in the Americas. VRT anticipates capital expenditures in the range of $175-200 million, differing from the pre-event analyst consensus of $150 million.
As it relates to sales, ongoing challenges in China are expected with relatively stagnant sales but expect continued growth exceeding market averages globally. While their margin expectations surpass the previous midterm target of 16%, which now seems closer to 20%, they fall below our earlier estimation due to additional investments in research and development as well as capacity expansions. Management has been able to outperform expectations over the past few years and there is a good likelihood that this guidance could prove to be slightly conservative. However, risk-reward at this point appears tilted to the downside following a ~260% rise in VRT's shares.
Lofty Expectations
VRT currently trades at 2.9X EV/'24 Sales. The EV/Sales multiples has expanded from ~1.3X to the current levels we see today. To put this 120% increase in the multiple into context, the 2023 increase in sales versus 2022 is expected to be 20%. This growth in sales is expected to cool to ~9.3% in 2024 versus the 2023 levels.
Similarly, VRT's EV/EBITDA multiple has also seen a stellar increase over the past 12 months, having risen from 8x to a nosebleed level of 16x at the time of writing. Analysts are currently modeling EBITDA rising by ~18% each year from 2023-2025.
As I covered earlier, VRT's business has been growing strongly on the coattails of the AI driven data center growth. However, very few businesses are immune to slowdowns. In case of VRT, there are two key risks that are worth considering:
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Spending Slowdown : A slowdown in spending growth from cloud or colocation customers, perhaps due to economic shifts or industry-specific changes, could dampen revenue growth.
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Margin Pressures : Margin misses might occur if the company faces challenges related to maintaining contribution margins. VRT has a high fixed cost base which is especially susceptible to economic slowdowns
While the US economy has been remarkably stable, we are seeing marked slowdowns in Asia and Europe, where VRT derives 44% of its revenues from. While this has slowdown has not affected VRT, the possibility of an impact to VRT remains.
Conclusion :
Vertiv has built a remarkable business that has years of growth ahead of it. VRT's focus on converting sales to FCF and shareholder returns through buyback is quite pleasing. The surge in Vertiv's stock reflects this and then some. It might be prudent to wait for a more favorable entry opportunity, considering the company's promising future but acknowledging the stretched valuation levels at this time. I would advise nibbling on VRT between $36-42/share. At these levels, the balance of risk and reward are more in the investors' favour.
For further details see:
Vertiv's Strategy Is Impeccable But The Market Has Gotten Ahead Of Itself