Technology | Barron's Stock Pick
This ‘Cool’ Stock Is More Than Just an AI Play. It’s Time to Buy.Concerns about spending on artifical intelligence have dinged shares of the data-center cooling company.
By
Jacob Sonenshine
Aug. 28, 2024 1:00 am ET
J.P. Morgan Securities analyst Stephen Tusa has a $100 price target on the Vertiv stock.
Illustration by Lynne Carty/Barron’s
The AI trade has given—and it has taken away. That has created a buying opportunity in the stock of Vertiv Holdings .
Vertiv isn’t an obvious AI play. It makes critical infrastructure products that cool and power data centers, and these days that’s a big business. When the company reported second-quarter earnings on July 24, investors got a sense of just how big. Sales grew by 13% and earnings jumped nearly 50%. Both numbers easily topped analyst forecasts. But instead of rising, Vertiv stock dropped 14%.
It was a victim of timing. Earnings from Alphabet , Amazon.com , and Microsoft raised concerns that companies have been spending too much on AI, which means not just chips, but also the infrastructure and cooling systems needed for data centers, Vertiv’s bread and butter. But there’s one problem: Vertiv’s business is too strong to get undermined by what looks to be a short-term concern.
“[The] negative narrative is playing more of a role than any of the numbers and hard evidence we see today, which ultimately matters the most,” writes J.P. Morgan Securities analyst Stephen Tusa, who has an Overweight rating and $100 price target on the stock, up 25% from Tuesday’s close of $80.21. “We stick with the numbers.”
There was nothing wrong with the Vertiv earnings. Vertiv reported slightly better-than-expected sales growth to $1.95 billion in the quarter. Profit margins increased as the company’s product prices and number of systems sold both rose, far outpacing all costs. Earnings rose to 67 cents on an adjusted basis, beating forecasts for 57 cents.
Management guided for full-year 2024 sales of $7.67 billion at the midpoint of its range, up $50 million from the previous outlook. But even those numbers seem conservative if the company’s margins continue to improve. “Operationally, margin trajectory continues to run ahead of consensus estimates, with [greater than] 20% margins now firmly achievable in our view for FY25,” writes Oppenheimer analyst Noah Kaye.
Investors, though, are concerned about Vertiv’s orders, which grew 57% year over year in the quarter but look set to decline in the third quarter from the second; year-over-year growth should still be in the double digits. Tusa isn’t worried. The company used words such as “strong” to describe the state of customer orders, without warning of risks. Tusa also said that the industrial equipment business is often “lumpy,” causing orders to fluctuate from quarter to quarter. More important, the company seems to have played it safe with conservative guidance and should be able to beat estimates when it reports third-quarter results in October.
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Growth is more than a quarter-to-quarter story. Tyler Walling, a partner at Otter Creek Advisors, estimates that the market for data center cooling products will hit $30 billion this year, up double-digit percentages from 2023. The total market is expected to grow at a low-double digit percentage rate annually over the coming eight years. “At the end of the day, long-term earnings drive this stock,” Walling says.
Vertiv will benefit from the industry growth. It is one of three players in the space, along with Eaton and Schneider Electric , that can provide customers with a full set of products and services. This allows Vertiv to lift prices a little bit each year, which helped sales of its data-center cooling products hit just over $5 billion of sales last year, or three-quarters of Vertiv’s total revenue of $6.9 billion. The rest came from industrial and communications customers.
Providing services for its products could also be another source of long-term growth. Vertiv employs thousands of engineers who help customers install and integrate new systems, but those services still represent the minority of total sales. Many customers haven’t yet used Vertiv’s services, which explains why the business grew by just 8% in the most recent quarter, but that should improve as companies deploy new systems.
“Services will typically lag product sales—as there is an initial warranty period that we offer on our products,” CEO Giordano Albertazzi tells Barron’s. “Services is a competitive advantage for Vertiv—and we believe that advantage grows as data centers become a much more complex environment.”
In the past, investors might not have felt comfortable trusting management. It had five quarters of earnings misses—four by double digits—between the end of 2019 and the end of 2022. But Vertiv has now beaten estimates in each of the past six quarters under Albertazzi, who took the helm in January of 2023. The company, unlike in some moments in the past, isn’t having issues collecting payments from Chinese customers and is managing its inventory, which enables it to maintain its pricing power and margins.
The recent selloff also has made Vertiv look more reasonably priced. It currently trades at about 25.8 times 12-month forward earnings, down from 32.8 times on July 24. That also means that the stock is now trading at a valuation closer to that of Eaton, which trades at almost an identical multiple, despite having double the expected growth and similar execution in the past chunk of quarters. Its valuation has fallen even as the price/earnings ratio for industrial stocks has risen to 21.4 times, near its highest level of the year.
That’s a reasonable valuation, especially because expectations are actually low. Tusa notes that the stock isn’t pricing in 60% revenue growth or order growth, but with a backlog that is up 50% from a year ago, growth should accelerate in 2025. “[Vertiv] is now an attractive risk/reward with accelerating revenues on best-in-class orders growth and best-in-class earnings upside, an uncommon combination,” Tusa says.
Let cooler heads prevail on this stock. It’ll power higher soon.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
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