Digital infrastructure technology player, Vertiv (VRT) is a company that stands to benefit tremendously from the explosion of data consumption across the world. This power and thermal management solution provider is poised for robust share price growth, thanks to the secular tailwinds in the data center, edge computing, and telecom industry.
Agreed that the company had to withdraw fiscal 2020 guidance despite robust growth in orders in the first quarter and some may see it as a sign of weakness. However, this move has been taken to be on the conservative side.
It will definitely not be wise for investors to punish the company for its conservative approach, especially since the business is all set to flourish due to an explosive increase in data usage in the current times. Vertiv has seen a 13% YoY order growth in the first quarter as demand has swollen in the cloud, large colocation, and telecommunication segments.
In this article, we will further analyze what makes Vertiv tick especially loud in the current environment.
The explosion of data across the world is a huge secular tailwind for Vertiv
In the first quarter, Vertiv reported a record backlog of $1.6 billion, mainly driven by the huge demand for internet services and a spike in content streaming from the locked-up population. This, in turn, has made the company’s power and thermal management solutions all the more important.
With the rapid increase in data comes an increased demand for additional processing and storage facilities. This has led to a surge in expansion activity for existing data centers as well as the construction of new data centers globally.
Vertiv estimates its total addressable market opportunity to be $29.5 billion, growing at 3% – 4% annually. Vertiv expects to grow at 1.5 times the pace of the overall market.
The scale and durability of the opportunity become even more apparent when we consider the above data boom related statistics. All these numbers point to a sustainable and ever-expanding market opportunity for Vertiv.
Vertiv currently holds a significant market share in all of its major end markets and is already in a place of strength to leverage on this secular tailwind.
Vertiv is well-suited to capitalize on this opportunity
With its broad portfolio of products and services in areas such as critical power, thermal management, racks and enclosures, and monitoring and management as well as maintenance services, Vertiv is already a dominant player in the digital critical infrastructure solutions space.
The above diagram highlights the diversified nature of the company’s business in terms of offerings as well as targeted markets. The company is also not overly dependent on any single customer, which is evident in the relatively small portion of revenue accounted by the first 50 customers. This diversification in terms of products, clients, and geographies lends a unique kind of stability to Vertiv’s business.
Besides being well-diversified, a significant portion of Vertiv’s revenues is recurring. A high degree of revenue visibility is considered to be an important investment criterion in times of increased macroeconomic uncertainty.
It is also not easy for newcomers to grab share in the digital infrastructure solutions market since it is capital intensive and technically complex. Clients are also more likely to continue with old trusted partners, considering the high switching costs involved. A new equipment infrastructure provider may not provide the appropriate level of monitoring and maintenance services. Besides, clients also require to train their technical personnel on the new systems. We see Vertiv having over 25 years of relationship with its clients. Navigating through such markets is no easy challenge for incumbents. These entry barriers can ensure abnormal returns for Vertiv for a longer time frame.
Investors should consider these risks
The Covid 19 pandemic has wreaked havoc with the global economy. In case the recession intensifies, the company may face challenges for small and medium-size customers currently serviced by IT channel partners.
The Covid-19 pandemic negatively affected the company’s revenues by ~$80 million and adjusted EBITDA by ~$30 million. Approximately 60% of the negative revenue impact was associated with supply-side disruptions while the remaining 40% was attributable to demand changes. Although the company has now managed to restart most of its manufacturing facilities across the world, they are not able to work at full capacity owing to supplier output challenges and logistics constraints.
In case of a rapid surge in Covid-19 cases, the government may force the shutdown of manufacturing activities for the company and its suppliers in the future. The pandemic is also causing access problems for Vertiv’s technical people to customer sites, which has further increased uncertainty about the fiscal 2020 performance.
Investor sentiment also plays a major role in valuations and unfortunately, the company may not be benefiting from that aspect. On December 10, Vertiv which was previously owned by Platinum Equity announced plans to go public. This was done by merging with SPAC (special purpose acquisition company), GS Acquisition Holdings Corp which is co-sponsored by Goldman Sachs Acquisition Corp and David M. Cote. The leveraged SPAC IPO model seems to have lost its investor appeal, especially in these uncertain times. Besides, the deal is pretty recent and the management will have to prove its mettle to actually implement the transaction appropriately. Since the new legal entity has a limited history, investors can be rightly concerned about the ability of the company to achieve its strategic and financial targets.
Vertiv also carries a significant debt of $2.2 billion on its balance sheet which is maturing in 2027. Of this, $1.0 billion in variable rate loan currently priced at 3.4%, while the remaining $2.2 billion in fixed-rate loan priced at 4.1%. A major portion of this debt is attributable to the company’s leverage SPAC merger. However, there also remains a positive side to this story. Vertiv has been successful in reducing annual cash interest outflow from $280 million to $90 million by refinancing higher-priced term loan and paying back high-interest notes in the first quarter.
Vertiv reported negative free cash flow in the first quarter and expects a slightly negative cash flow in the second quarter. However, the company expects to report positive free cash flow for fiscal 2020. In case the company misses on this projection, it may not bode well for its share prices.
Vertiv’s adjusted EBITDA margins also remain a sore point for investors, considering that they are around 500 basis points lower than their peers. The company, however, is working to improve them through optimal product mix, implementation of Vertiv operating system, SG&A optimization, fixed cost optimization, and geographical market expansion. Investors should keep an eye on how the company’s margins are trending in the coming quarters.
What price is right here?
According to finviz, the 12-month consensus target price for the company is $17. The company is currently trading at a forward PE of 13.12x and PS multiple of 5.25x. I believe that the current valuation is pretty low considering the company’s growth prospects in the current environment. The consensus target price seems to be a better reflection of the fair value of the stock.
The company also ranks solid on the liquidity front with $446 million available at the end of March 2020. Of these, $289 million in unrestricted cash while $157 million is available under an asset-based lending facility. Besides, the company does not expect its liquidity to fall below $300 million even in the worst-case scenario of a 25% drop in topline.
This is a less covered stock. On May 7, Deutsche Bank analyst Nicole DeBlase raised target price to $17 from $11 and reiterated a Buy rating. On April 9, Deutsche Bank analyst Nicole DeBlase upgraded the company’s rating to Buy from Hold and target price to $11 from $9. On March 13, Goldman Sachs analyst Mark Delaney initiated coverage with a Buy rating and $12 price target.
The robust growth in end markets will more or less translate into top line and bottom line growth for Vertiv in the coming years. Hence, I believe that retail investors with above-average risk appetite and average investment horizon of one to two years should definitely consider adding this Covid-19 resilient stock to their portfolios in 2020.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.