While there has been a recent uptick in cyclical stocks, artificial intelligence (AI) shares have experienced significant growth throughout 2023. AI beneficiaries have led the equities market in the first three quarters of the year, and this trend is expected to continue into 2024. Vertiv Holdings (NYSE:VRT) is a company that stands to benefit from the AI boom. As an electrical product manufacturer focused on data centers and telecom, Vertiv generated $5.7 billion in revenue in 2022. The company’s key product offerings include power & thermal management, IT management, and related services. With a market cap of $18.6 billion, Vertiv trades at a high forward 12-month non-GAAP price-to-earnings ratio and pays a low forward dividend yield. While earnings are not expected until February, the stock has a relatively high implied volatility percentage of 43% and a modest short interest of 2.9% as of December 26, 2023.
In October, Vertiv reported a somewhat weak quarter, with Q3 GAAP EPS falling short of consensus forecasts and revenue largely in line with estimates. However, the company saw growth in its adjusted operating margin and exceeded Wall Street’s expectations for free cash flow. This positive performance, along with the potential for expanding manufacturing capacity in response to rising demand for AI, has buoyed investor sentiment.
Vertiv’s management team has expressed a bullish earnings outlook, with increased sales, adjusted operating profits, and free cash flow expectations. However, there are some risks to consider, such as weaker demand for data centers if the AI theme cools down and weaker pricing power due to growing global competition. The company aims for 8% to 11% annual organic revenue growth from 2023 to 2028. It has also announced a $3 billion share buyback program and a goal to lower net debt, which should reduce leverage.
Analysts at Bank of America Global Research have named Vertiv as a top pick in its industry, with operating EPS expected to approach $3 by 2025 and per-share profits more than tripling this year. The consensus earnings outlook indicates annual growth above 20% in the coming years, with revenue expected to advance by more than 20% this year. While no dividends are expected, Vertiv’s free cash flow yield is projected to rise above 5% in the coming quarters.
Despite its strong growth history and outlook, Vertiv’s valuation is currently high compared to its peers. However, the company’s sanguine growth trajectory may support this premium valuation. Taking into account a low to mid-20% EPS growth rate and applying the sector median PEG ratio, the stock price could be in the high 30s. Considering the 5-year average P/E ratio of 21, a more appropriate valuation may be in the mid to high $40s based on 2024 EPS projections.
Overall, Vertiv has a high valuation but offers strong growth potential and profitability. GARP investors can feel confident in the stock’s rising free cash flow figures. With industry-leading share-price momentum and a technically strong chart, Vertiv is an attractive option. However, caution should be exercised regarding the valuation, as the current operating earnings multiple is well above the 5-year average. The stock price has the potential to reach near $50 based on technical patterns, but support is expected near $43. In conclusion, a hold rating is recommended for Vertiv.
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