Vertiv Holdings: To Benefit From Strong AI And Margin Growth (NYSE:VRT)

Vertiv Holdings (NYSE:VRT) looks like a promising long-term stock as the company has strong, above-average growth with an attractive valuation. The strong expected growth for the Data Infrastructure market should provide a positive tailwind for Vertiv through the decade and beyond.

Vertiv is involved in the designing, manufacturing, and servicing of critical digital infrastructure and life cycle services for data centers, communication networks, and commercial/industrial environments in the United States and internationally. This includes the powering, cooling, securing, and maintaining of the electronics that process, store and transmit data. The company aims to create technology with high reliability.

Positive Growth Outlook

One of the driving forces for Vertiv’s growth is the 12% projected annual growth for the Data Center Infrastructure market. This market is expected to grow to from $57 billion in 2022 to $183 billion by 2032.

Vertiv fits right into this projected growth since the market shifted towards edge computing which demands faster and more efficient data processing. Vertiv’s power, cooling, and monitoring solutions can help customers achieve these demands. The company also provides racks/enclosures and services which are likely to experience strong demand during this industry growth.

AI (artificial intelligence) is one of the growth drivers for Vertiv. The company believes that AI will increase Vertiv’s total addressable market. Vertiv stated that it is beginning to get orders for AI-related infrastructure.

Vertiv has solutions for air cooling AI-related data centers. Vertiv also has solutions for liquid-cooling servers and racks, which a portion of the market may shift to within the AI market. Vertiv is positioned well for a hybrid solution as it has the widest selection of thermal technology available and a high level of expertise to deploy these solutions.

Vertiv has over 3,500 engineers throughout the world to support AI-related infrastructure building & maintenance. The company has the ability to increase this capacity as demand increases (as anticipated) over the next several years.

VRT is expected to grow revenue at a strong 20% in 2023 and follow this up with a 7% gain in 2024. EPS are expected to grow 203% in 2023 and 21% in 2024. The unusual high expected growth for EPS in 2023 is due to significant increase in margins. The gross margin increased from 28% in 2022 to 32% for the trailing 12 months. Operating margin increased from 4% in 2022 to 9.6% for the trailing 12 months. Net income margin increased from 1.35% in 2022 to 2.84% over the past 12 months.

Vertiv’s significant increases in margins were the result of effective operational execution and fixed cost leverage. The company expects to make continued gains in operating margin from just under 10% currently to the teens and eventually to 20% and above over the long-term. The plan to achieve this is by improving the contribution margin while also employing fixed cost leverage. If these goals are achieved, Vertiv has the potential to make significant earnings gains over the next several years.

Attractive Valuation

I strongly believe that the PEG ratio is the most appropriate valuation metric to use for Vertiv. The reason for this is because the PEG ratio takes multiple years of future expected earnings growth into account. The PEG ratio tends to be a good valuation measure for high growth companies. The PEG is appropriate for Vertiv which has strong expected average annual earnings growth of 59% for the next 3 to 5 years.

With that said, Vertiv is trading with a PEG ratio of 0.41. This is lower than the sector median PEG of 1.6 and the Electrical Equipment & Parts industry’s PEG of 1.03. Typically, I’m pleased to see PEG ratios between one and two for profitable, high-growth stocks. The growth stocks that I cover tend to perform well with a PEG ratio in this range. So, when I see Vertiv with a PEG below one, that leaves even more room for the stock to run higher in my view.

Technical Perspective

Vertiv’s stock price shows a recent dip from the 52-week high of $43. This dip occurred not as a result of any specific company news. The stock was caught up in the 1.2% decline in the tech-heavy Nasdaq index on Friday, October 13. Vertiv’s stock fell by a sharp 6.5%. The sharp sell-off was probably a result of profit taking by large investors to lock in profits after this year’s strong run.

It is not clear whether this sell-off will continue. The MACD indicator (middle of chart) is still in bullish territory above the zero line and with the blue line above the red signal line. However, the histogram shows a two-day weakness in the momentum (bars shifting from dark green to light green).

The purple RSI line (bottom of chart) recently dropped from a near overbought condition. The RSI also briefly crossed below its yellow moving average line, indicating that there could be a change in trend from positive to negative. However, Monday’s bounce back brought the RSI line back above its moving average. Investors may want to see how the Nasdaq and Vertiv trade in the near term. A continuation of the sell-off would create a better entry point for potential investors.

I would also point out that there is a bearish divergence between the rising price and the declining trend in the MACD and RSI over the past 2 months. This could indicate that the sell-off may continue. This is the biggest risk for the stock in the near term in my opinion. Of course, investors could use the weakness in the stock to pick it up at a lower price.

Balance Sheet/Cash Flow

Vertiv has $275 million in total cash & equivalents and about $3 billion in total debt (excluding capital leases). This leaves the company with about $2.7 billion in net debt. The balance sheet shows VRT with 1.6x more current assets than current liabilities and 1.3x more total assets than total liabilities for total equity of $1.66 billion.

The high debt in relation to cash does present a potential risk for Vertiv. If the company experienced a significant decline in revenue, it could have a negative impact on Vertiv’s ability to pay its obligations. That situation would also make Vertiv less flexible with running the business. With that said, Vertiv is currently thriving with strong revenue growth. As a result, the company is using leverage to its advantage to grow the business.

Vertiv has strong cash flow to handle its debt. The company had $481 million in operating cash flow over the trailing 12 months. This was a significant improvement over the negative $153 million from 2022 and the positive $211 million from 2021. Vertiv issued $503 million in new debt but paid off $718 million over the trailing 12-month period. Vertiv doesn’t typically repay more than it issues in any given year. So, the past 12 months was an aggressive repayment period. That speaks to Vertiv’s ability to handle large obligations.

Vertiv Holdings Long-Term Outlook

Overall, I like how Vertiv is navigating in a growing market. The company is positioned well to benefit from the long-term growth in the Data Center Infrastructure market which includes AI. Vertiv demonstrates strong expertise in this space and appears ready to scale up to handle increased demand.

Vertiv is flexible to handle the changing needs of the industry. This includes shifting to a hybrid system of air and liquid cooling being driven by AI. The company appears confident to provide effective solutions in this dynamic, growing market with its products and team of engineers. As a result, Vertiv should achieve strong above-average revenue/earnings growth through the decade. With a low valuation, I believe the stock is likely to make above-average, market-beating gains from this growth.