By Jacob Sonenshine

Vertiv had been one of the market's hottest stocks -- until DeepSeek and tariffs cooled off shares of the cooling-systems maker. It looks like a buying opportunity.

Shares of Vertiv were sitting pretty not so long ago. We had recommended the stock in late August when it traded for $80, arguing that demand from hyperscalers -- think Microsoft, Alphabet, Meta Platforms, Amazon.com, Apple -- build their data centers, buy more chips for them, and demand more of the data center power and cooling products that comprise the majority of Vertiv's revenue.

Vertiv is one of three companies, along with Eaton and Schneider Electric, that makes the equipment, and it also provides services to maintain the products. That combination has positioned it as a reliable provider and given it pricing power, which, when combined with additional product sales, helped push profit margins higher. The result? Extraordinary earnings growth that boosted the stock to $153.49.

Then the stock got crushed. On Jan. 27, DeepSeek panic claimed U.S. AI plays. The issue is that DeepSeek provides what seems to be a functional artificial-intelligence platform for a fraction of the computing power and cost. If that's the case, fewer data centers will be built, and demand for cooling products will be lower than anticipated. Tariffs complicate matters as well since Vertiv does some of its manufacturing in China and Mexico. At a recent $111, shares have fallen 28% since their Jan. 23 peak, though they are still up 39% since we recommended them.

The concerns are real. If DeepSeek does what it claims it does, the demand for cooling products will be lower than previously anticipated, which would mean that the market for cooling is oversupplied, and prices will have to fall. But they may also be fully reflected in the stock, according to JPMorgan analyst Stephen Tusa.

Tusa did what any analyst should do -- he explored the worst-case scenario. If DeepSeek can do what it claims to do, Vertiv would have to lower prices, which would offset some mild growth in the number of products sold. He also assumes that the hyperscalers won't cut back in a big way immediately and that management would exercise enough cost discipline to maintain margins and keep earnings from declining. Ultimately, that could allow sales to hit $11.3 billion in 2026, before flattening out in 2027. (The numbers don't consider the impact of tariffs.)

Tusa is fine with that. With demand reset, growth should return after that. First off, Vertiv has Jevon's Paradox -- the theory that as a technology becomes cheaper and more accessible, more people will use it -- on its side. Over the long-term, most people and businesses worldwide will use AI, so demand for chips -- and Vertiv's cooling equipment -- will grow. The reality is that broader AI adoption globally is at about 40%, suggesting years of growth ahead, given that the internet and computers took decades to reach full adoption.

This would spur high earnings growth long-term. Vertiv wouldn't have to aggressively increase operating expenses, given that it's well-positioned as one of the three providers of these products, so margins would re-expand. The company would continue to repurchase stock, further boosting earnings per share. This would produce above 20% annual EPS growth.

That would push shares higher, especially if the multiple of earnings moves up. Even assuming that EPS are flat in 2027 judging by consensus estimates, the stock doesn't look expensive, at 25 times that number. That multiple is almost equal to its earnings growth, the lowest PEG (price/earnings ratio divided by growth rate) among the industrials Tusa covers.

"The pull back looks overdone," writes Tusa, who has an Overweight rating and $132 price target on the stock, up 19% from Tuesday's close. "[We] see an attractive risk/reward as a result."

In other words, keep a cool head about this one.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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February 05, 2025 03:00 ET (08:00 GMT)

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