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My rating for VNET Group, Inc. (NASDAQ:VNET) stock is a Buy. VNET’s key Q2 financial metrics were better than what the analysts had anticipated. Looking forward, the company expects to achieve a faster pace of revenue and EBITDA growth for full-year FY 2024. VNET’s positive financial prospects suggest that a more demanding EV/EBITDA multiple for the stock is justified. As such, I have upgraded my rating for VNET from a Hold previously to a Buy now.
The current write-up reviews VNET’s financial results for the second quarter of 2024. My earlier March 28, 2024, update touched on the company’s fiscal 2024 financial outlook and its credit profile.
Q2 Revenue And EBITDA Exceeded Expectations
The company’s key Q2 2024 financial numbers disclosed in its latest quarterly results press release came in above expectations.
VNET’s second quarter revenue of RMB 1,993.8 million was +3.3% higher than the consensus top-line estimate of RMB 1,930.6 million, while its Q2 normalized EBITDA of RMB 573.8 million was +5.3% above the consensus forecast of RMB 545.0 million. The sell-side analysts’ consensus numbers were obtained from S&P Capital IQ.
The top line and non-GAAP adjusted EBITDA for VNET rose by +9.4% YoY and +7.3% YoY, respectively in Q2 2024.
In its second quarter results release, VNET explained that the company’s “IDC (Internet Data Center) business was subdivided into wholesale IDC business and retail IDC business according to the nature and scale of our data center projects.”
The wholesale IDC business was the star for VNET in the most recent quarter, with a +81.0% YoY surge in revenue to RMB 402.0 million. VNET highlighted at the company’s Q2 2024 analyst call that its wholesale IDC business “secured a significant 200 megawatt order from an existing customer in the Internet industry” for the latest quarter. The strong performance of VNET’s wholesale IDC business allowed the company to deliver a +3.3% top-line beat in the second quarter.
In comparison, the company’s retail IDC business’ revenue contracted by -3.2% YoY to RMB 964.8 million for Q2 2024. Separately, revenue for VNET’s non-IDC business engaged in Virtual Private Network and cloud services increased by +4.0% YoY to RMB 627.0 million in the latest quarter.
On the other hand, VNET’s +5.3% EBITDA beat was driven by both above-expectations revenue growth as mentioned above and better-than-expected operating profitability.
VNET registered a non-GAAP adjusted EBITDA margin of 28.8% in the second quarter of this year. This was +0.6 percentage points ahead of the market’s consensus projection of 28.2% based on S&P Capital IQ data. The company’s Q2 2024 EBITDA margin surpassed expectations due to good expense management, as evidenced by a -7.7% YoY decline in VNET’s operating costs to RMB 230.3 million for the recent quarter.
Anticipating A Faster Pace Of Top Line And EBITDA Expansion For 2024
The company is guiding for a +5.2%-7.9% growth (mid-point: +6.5%) in revenue and a +8.9%-11.8% increase (mid-point: +10.3%) in normalized EBITDA in FY 2024. As a comparison, VNET’s top line and non-GAAP adjusted EBITDA rose by +4.9% and +8.9%, respectively in fiscal 2023.
I take the view that there is a reasonably good chance of VNET witnessing revenue and EBITDA growth acceleration in the current fiscal year as per its management guidance. This is because VNET’s key Q2 2024 financial drivers are likely to be supportive of the company’s full-year results as well.
A key financial driver for VNET is its wholesale IDC business.
The wholesale IDC business’ backlog expanded by a significant +10.8% QoQ to 1,139 MW in the second quarter of 2024 according to the company’s disclosures in its results presentation slides. This has a favorable read through for VNET’s future top-line performance, as a growing backlog will most likely translate into higher revenue for the wholesale IDC business in time to come.
The company’s wholesale IDC business is a beneficiary of AI tailwinds. At its second quarter analyst briefing, VNET disclosed that “the vast majority of” its latest new orders for the wholesale IDC business relates to “AI deployment” for its clients.
In the company’s Q2 earnings presentation slides, VNET emphasized that more than 95% of its “wholesale capacity in service is capable of meeting high-performance computing power requirements.” This places VNET’s wholesale IDC business in a good position to win AI-related orders going forward.
The other major financial driver for VNET is the company’s cost management efforts.
In the preceding section, I touched on how the company was able to achieve a -7.7% decrease in operating expenses and still register a +9.4% YoY growth in top line for Q2 2024.
Moving ahead, VNET stressed at its Q2 2024 earnings call that it will “continue to refine cost control measures” and place a greater “emphasis on profitability” by “increasing efficiencies.”
The mid-point of VNET’s full-year fiscal 2024 financial guidance implies that the company’s non-GAAP adjusted EBITDA margin is expected to improve from 27.5% last year to 28.5% this year. This appears to be reasonable, considering VNET’s focus on expense management and favorable operating leverage effects resulting from revenue growth acceleration.
VNET is now valued by the market at a consensus next twelve months’ normalized EV/EBITDA multiple of 7.3 times, according to S&P Capital IQ data. In contrast, the company’s non-GAAP adjusted EBITDA is anticipated to grow by +10.3% for full-year FY 2024 based on the mid-point of its guidance. As another comparison, the consensus FY 2023-2026 EBITDA CAGR forecast for VNET is +13.0% based on data taken from S&P Capital IQ.
In my view, VNET deserves to trade at a higher EV/EBITDA metric at the low-teens level. This is consistent with the valuation rule of thumb that a stock is fairly valued if its earnings multiple is equal to its projected earnings growth rate. The expected EBITDA growth for VNET is +10% or better, so it will be reasonable that VNET trades at an EV/EBITDA ratio exceeding 10 times.
Risk Factors
I will pay attention to two specific risks for VNET.
One risk is that the company’s wholesale IDC business underperforms due to weaker-than-expected AI-related demand.
Another risk is that VNET witnesses an unexpected increase in costs because of a failure to execute well on its expense optimization initiatives.
Conclusion
VNET Group, Inc.’s above-expectations Q2 2024 results and its favorable financial prospects are good reasons to turn positive on the stock. I believe that the stock is worthy of a higher EV/EBITDA ratio and a Buy rating, considering its EBITDA growth outlook.
