VRT’s stock price is near all-time highs, and analysts have a positive outlook on the company.
While there has been some catch-up in cyclical stocks in the last two months, artificial intelligence (AI) shares have soared throughout 2023. AI beneficiaries led equities through the first three quarters of the year, and 2024 sets up well for many of these stocks- some with share prices near all-time highs.
I reiterate my hold rating on Vertiv Holdings (NYSE:VRT). I see a much stronger earnings and free cash flow trajectory over the coming years, while a new stock buyback plan puts the focus on the shareholder.
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 $18.6 billion market cap Electrical Components and Equipment industry company within the Industrial sector trades at a high 28 forward 12-month non-GAAP price-to-earnings ratio and pays a low 0.05% forward dividend yield. With earnings not due out until February, shares trade with a still-high implied volatility percentage of 43% while short interest on the stock is modest, though material, at 2.9% as of December 26, 2023.
Back in October, Vertiv reported a somewhat weak quarter. Q3 GAAP EPS of $0.24 fell short of the $0.32 consensus forecast while revenue of $1.74 billion, up 18% from the same period a year earlier, was largely in line with estimates. What I found encouraging, though, was that it grew its adjusted operating margin to 17%, up nearly 800 basis points from Q3 last year – a key number for this data-center firm as its margins had been lagging some of its peers while leverage was to the high side.
Free cash flow of $221 million soared past Wall Street’s outlook, helping to give some hope to the bulls after the stock had given back some gains on earnings day. Despite the near-term selloff, the bulls stepped back in, perhaps on the realization the VRT now has the opportunity to expand its manufacturing capacity in light of rising demand for AI.
Also encouraging was the management team’s bullish earnings outlook. Vertiv now sees 2023 adjusted EPS between $1.69 and $1.73, up from the $1.54 to $1.64 range, along with higher sales and adjusted operating profits. Free cash flow expectations jumped 14% from the previous guidance midpoint. Key risks for Vertiv include weaker demand for its data centers should the AI theme cool next year and weaker pricing power from growing global competition.
I was also a bit unimpressed with the toned-down view expressed at its November Investor Day. The management team had a cautious outlook on AI, but it still aims for 8% to 11% of annual organic revenue growth from 2023 to 2028, above its historical growth rate. Buoying the sentiment at the event was the announcement of a $3 billion share buyback program and goal to lower net debt, which should reduce its leverage. Close to $5 billion in free cash flow is now projected from 2024-2028 (cumulative). Amid these bullish trends, analysts at BofA named VRT as a top pick in its industry
On valuation, EPS and free cash flow expectations have increased significantly since I last reviewed the company in the summer. BofA now sees operating EPS approaching $3 by 2025 with per-share profits more than tripling this year. The current consensus earnings outlook, per Seeking Alpha, is about on par with what BofA sees – with annual growth above 20% through the out years.
Revenue is seen advancing by more than 20% this year, and then easing to a high-single-digit pace. No dividends are expected to be paid on this fast-growing firm, and its trailing 12-month EV/EBITDA ratio is higher than the market’s average, but not extraordinarily so. Finally, GARP investors can appreciate how VRT’s free cash flow yield, even with a premium valuation, is seen rising above 5% over the coming quarters.
I still have my concerns over the valuation, as VRT’s current operating earnings multiple is well above its 5-year average. If we take a different approach, though, we see that the more sanguine growth trajectory may support such a valuation premium.
If we assume a low to mid-20% EPS growth rate and apply the sector median 1.8 PEG, then the P/E could be in the high 30s, implying a stock price near $80. I would temper that valuation considering that the 5-year average P/E is just 21. It may be more appropriate to apply that multiple on 2024 EPS of $2.21 (consensus), suggesting a stock price in the mid to high $40s, near fair value today.
Compared to its peers, VRT has a high valuation, but its growth history and outlook are downright stellar. Moreover, profitability trends are robust, and GARP investors can feel confident that owning the stock means accessing shares of a firm with rising free cash flow figures. With industry-leading share-price momentum and the stock near all-time highs, VRT is also a technician’s dream. Sellside analysts also favor Vertiv, too – EPS revisions have been nothing but up in the last three months (10 up, zero down).
Looking ahead, corporate event data provided by Wall Street Horizon show an unconfirmed Q4 2023 earnings date of Wednesday, February 21 BMO. No other volatility catalysts are seen on the calendar.
With a much stronger earnings and free cash flow outlook, VRT’s chart is among the strongest you will find in today’s market. Notice in the graph below that shares are very close to all-time highs. “The bigger the base, the higher the space,” they say, and I see technical upside to near $50. I arrived at this figure based on a key technical pattern from the last few years. VRT peaked just shy of $29 in September 2021 before plunging under $8 by mid-22. Shares then recovered throughout the back half of 2022 before gapping higher post-earnings back in August. That breakaway gap triggered an upside-measured move price objective to $50, right where the stock is today.
Of course, there are few technical features more bullish than no natural sellers to supply the market above the current price. That is the situation we face today with VRT. Instead, there’s just modest volume by price down to about $35 with hardly any shares traded between the upper $20s and mid-$30s. With a rising 200-day moving average, the bulls appear in control, and I like what I see in the RSI momentum gauge at the top of the graph – VRT worked off technical overbought conditions and a bearish RSI divergence. I see support near $43 while the $50 measured move target remains in place on the upside with no other resistance.
Overall, VRT’s chart is very strong and technicals suggest shares could continue to rise in 2024.
I reiterate my hold rating on VRT. The valuation looks fair to me given upwardly revised earnings expectations, while the technicals are very strong amid bullish momentum trends.
