VERTIV HOLDINGS CO VRT
March 06, 2022 - 10:17pm EST by
quads1025
2022 2023
Price: 10.57 EPS 0.71 1.54
Shares Out. (in M): 376 P/E 14.9 6.9
Market Cap (in $M): 4,000 P/FCF 26.6 6.9
Net Debt (in $M): 2,500 EBIT 525 910
TEV ($): 6,500 TEV/EBIT 12.4 7.1

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Description

 

Executive Summary

VRT is an attractive long opportunity as it appears to be a classic situation of a good company struggling through temporary issues.  Based on financial projections presented below, the stock could trade back to $23, or up >100% from current levels.

 

Importantly, this opportunity could play out very rapidly.  If VRT reports 1Q22 earnings in-line with their guidance and indicates things are tracking to plan for the remainder of 2022, that should be enough to cause the stock to retrace most of what the stock lost in its recent "earnings blow up".  Getting to $23 will likely take a bit longer, but probably only another quarter or two.  By then, the market will have gained comfort with projections for 2023 and will have started "rolling forward" its PE valuation multiple on 2023E EPS.  VRT management will also be attending the JPMorgan Industrials Conference in New York on March 15-17.  This could also serve as a catalyst for the stock.

 

Company Description

VRT manufactures electrical equipment that powers, cools, deploys, secures and maintains electronics for data transmission.  In essence, the Company supplies the hardware equipment for the operation of data centers.

 

VRT has been written up on VIC in the past. For a more thorough description of the business, please see leob710’s write-up posted on 9/9/20.

 

The Opportunity

In response to VRT’s 4Q21 earnings, the stock dropped ~45%, creating this very attractive buying opportunity.  VRT’s 4Q21 results and its guidance for 2022 were both well below expectations.  As VRT stock has been a crowded hedge fund name for some time and the poor financial results were completely unexpected, it’s not surprising that VRT’s stock plummeted.

 

What’s important to focus on is the reason why VRT’s results and 2022E guidance were so far below expectations.  The Company isn’t facing business demand issues, which is a hard-to-fix problem.  The Company is facing cost issues, which can be more easily addressed.

 

Demand for VRT’s business remains extremely robust.  The Company’s backlog reached a new record at $3.2bn at the end of 2021, up 73% from 2020.

 

The reason VRT’s 4Q21 results were so poor and guidance for 1H22 was weak is that the Company underestimated inflationary pressures as well as the severity of supply chain issues.

 

When VRT reported 3Q21 earnings on 10/27/21, they already had the first month of 4Q21 behind them, and issued 4Q21 guidance accordingly.  While November was a so-so month for the Company, things really fell apart in December, according to management.  Freight costs expanded significantly, and suppliers weren’t able to provide VRT with essential parts.  This caused VRT management to scramble and buy parts on the spot market which is much more expensive.  Further, VRT had to pay premium freight charges in order to satisfy customer orders.  On top of all this, VRT was in the process of integrating a new ERP management system, so management didn't have the visibility they needed into all the moving parts of the Company.  Most importantly, VRT management recognized that from a cultural perspective, the sales force, which sets the price for VRT products, weren’t talking with the operational guys, who source the parts. This lack of communication resulted in the sales force underpricing VRT products in comparison to the cost of parts, leading to price/cost being highly negative.

 

To gather more detail/insight into the above, a thorough reading of the transcript of VRT’s 4Q21 earnings call is highly encouraged.

 

The Path Forward

To correct things going forward, VRT has implemented pricing initiatives which should cause price/cost to be neutral in 2Q22 and positive thereafter, such that price/cost will be a $100mm tailwind for 2022.  The sales force has already pushed the price increases through (they could do this because of VRT’s product differentiation in the market place).  However, it takes several months for the pricing to flow through VRT’s financials, as management emphasized on the 4Q21 earnings call.  Accordingly, results for 1Q22 are expected to be weak (even lower than 4Q21), and then results should show improvement in 2Q22, and then “hockey stick” upwards in 2H22.

 

Admirably, management has embraced the mentality to “overcommunicate” with the Street on how they see 2022 unfolding.  This is why they have presenting detailed figures on a quarter-by-quarter basis in their 4Q21 earnings presentation.

 

Key Risk

Management currently faces a "credibility" problem with investors after (i) having really messed up 4Q21 vs. their guidance and (ii) not having a better handle on the cultural/communication issues within the Company.  Accordingly, it will take time for investors to regain confidence in VRT's management.  If VRT can demonstrate recovery in their story in 1Q22 and 2Q22, the stock should be driven upwards.

 

In general, VRT management is viewed favorably by investors and they are seen as competent, particularly Dave Cote who is chairman of VRT's board and the former CEO of Honeywell.  Given how frank management was on how they screwed up and how they aren't going to let it happen again in the future, I'm inclined to give them the benefit of the doubt.

 

Risk/Reward Profile

The risk/reward profile is heavily skewed to the upside.  As shown in the Financial Analysis below, if VRT management can execute their plan it is reasonable to project VRT can generate $1.54 in 2023E EPS.  Applying a 15.0x PE multiple on this equates to a $23 stock, or ~$12 up.  In a Downside Scenario where VRT generates $1.00 in 2023E EPS and trades at a reduced 10.0x PE multiple, the stock would be $10.00, only slightly below current levels (or ~$1 down).  Of note, prior to this “earnings blow up”, VRT historically traded in a range of 15-25x 1-yr forward EPS, based on Bloomberg data.  A 15.0x PE multiple is at the bottom of that range and is thus appropriately conservative.

 

Financial Analysis

The data in the analysis below is based on management’s guidance as presented in their 4Q21 earnings presentation.  Please see figures in Slides 13, 24, 25 and 26, in particular.  The bridge analysis on Slide 28 is also very helpful.

 

Vertiv (VRT)                          
Summary Model                          
($ in millions)                            
                               
                               
      1Q 2021 2Q 2021 3Q 2021 4Q 2021 2021   1Q 2022E 2Q 2022E 3Q 2022E 4Q 2022E 2022E   2023E
                               
Revenues   $ 1,098.4 $ 1,260.3 $ 1,228.9 $ 1,410.5 $ 4,998.1   $ 1,125.0 $ 1,340.0 $ 1,505.0 $ 1,680.0 $ 5,650.0   $5,989.0
  Growth, %   N.A.   N.A.   N.A.   N.A.   N.A.     2.4% 6.3% 22.5% 19.1% 13.0%   6.0%
                               
EBIT   111.6 134.1 131.4 93.9 471.0   (20.0) 90.0 200.0 255.0 525.0   910.3
  Margin, %   10.2% 10.6% 10.7% 6.7% 9.4%   (1.8%) 6.7% 13.3% 15.2% 9.3%   15.2%
                               
Int. Exp.   24.1 20.0 22.4 24.1 90.6   30.0 31.0 32.0 33.0 126.0   126.0
Other   (0.4) 0.0 0.0 0.0 (0.4)   0.0 0.0 0.0 0.0 0.0   0.0
                               
Pre-Tax Income 87.1 114.1 109.0 69.8 380.0   (50.0) 59.0 168.0 222.0 399.0   784.3
                               
Taxes   10.0 1.3 35.7 54.8 101.8   15.0 19.0 43.0 55.0 132.0   204.3
  Rate, %   11.5% 1.1% 32.8% 78.5% 26.8%   (30.0%) 32.2% 25.6% 24.8% 33.1%   26.1%
                               
Net Income   $ 77.1 $ 112.8 $ 73.3 $ 15.0 $ 278.2   ($ 65.0) $ 40.0 $ 125.0 $ 167.0 $ 267.0   $ 580.0
                               
FD EPS   $0.21 $0.31 $0.20 $0.04 $0.77   ($0.17) $0.11 $0.33 $0.44 $0.71   $1.54
                               
FD Shares Out. 358.8 362.1 363.2 372.2 360.1   377.0 377.0 377.0 377.0 377.0   377.0
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

The main catalyst for VRT's stock will be their 1Q22 earnings report (late April, early May).  If VRT reports 1Q22 earnings in-line with their guidance and indicates things are tracking to plan for the remainder of 2022, that should be enough to cause the stock to retrace most of what it lost in the recent "earnings blow up".  Getting to $23 will likely take a bit longer, but only another quarter or two. By then, the market will have gained comfort with projections for 2023 and will have started "rolling forward" its PE valuation multiple on 2023E EPS. 

VRT management will also be attending the JPMorgan Industrials Confernce on March 15-17.  This could also serve as a catalyst for the stock.

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