The Secret AI is up 1,200% in two years, loved by small-cap stars

Modine appeared in the American Elite Companies Top 10 last week.

Modine production (US:MOD), a heating and air conditioning company, is seen as contributing to the growth of AI and data centers.

Data centers are very energy intensive and generate a lot of heat when in use. This increases the demand for Modine’s cooling products, such as immersion cooling and cooling distribution units. The excitement has contributed to the stock’s incredible 1,200% rise over the past two years.

It’s not hard to understand the enthusiasm given the company’s guidance that its data center business should have grown revenue by 60-70% over the financial year to the end of March, which it will report on next week.

“Although currently a small percentage of Modine’s total revenue, data center cooling is expected to experience substantial growth due to the expansion of the AI ​​ecosystem and could account for as much as 25% of revenue within four years ” said Michael Coyne and Mitchell Brivic, managers of the Voya Small Cap Growth fund, in their first quarter client commentary.

However, there is more to Modine’s incredible price gains and popularity among top fund managers.

The Voya Small Cap Growth managers are among 16 Elite Investors backing Modine, all of whom are in the top 3% of the 10,000 global equity managers tracked by Citywire. The high level of support from Elite Investors, most of which are small-cap specialists, has led to Modine receiving a AAA rating from Elite Companies and it is also one of the top 10 US smart money picks.

How Citywire Elite Companies Works

Top three elite financiers

Sources: Citywire/Morningstar, latest holding data.

Beyond AI

Modine’s AI success is part of a larger long-term strategic transformation of the group, which started in 1916 as a manufacturer of tractor radiators.

Data center cooling is one of the many growth markets where the company is focusing its sales efforts. Others include electric vehicle cooling systems and markets that benefit from U.S. government subsidies, such as school heating and cooling systems and heat pumps.

This is part of a strategy launched in 2022 called ’80/20′. The name refers to the fact that Modine estimates that about 80% of its returns come from just 20% of its activities.

In addition to the focus on growth markets, the intention is to concentrate that high-quality 20% of the activities. Essentially, Modine wants to sell more systems, services and software and fewer components.

By encouraging investment in these areas, Modine believes it will reduce capital requirements while improving profitability and boosting growth. That’s a great recipe for creating more shareholder value.

“Management continues to exit lower-margin businesses – the internal combustion automotive industry – in favor of fast-growing markets – electric vehicles and data centers. We are confident that these initiatives will deliver strong revenue and Ebitda [earnings before interest tax depreciation and amortisation] growth in the future,” said Coyne and Brivic.

Better

The results are already impressive and significant further progress is predicted.

Modine targets annual revenue growth of 8-10% between 2025 and 2027, an Ebitda margin of 13-14% and a free cash flow margin of 6-8%. This compares to declining sales, a 7.7% margin and negative free cash flow before the launch of 80/20.

Bolt-on acquisitions are used to advance the group’s plan. The company has also said that larger strategic deals will be considered in the future. With net debt of just £184 million at the end of 2023, the country has the balance sheet to support this.

The exceptional performance of the data center business has contributed to major upgrades to brokers’ forecasts. Earnings per share (EPS) expectations for the recently ended fiscal year are up 36% in twelve months, while forecasts for the current fiscal year are today 29% higher than a year ago.

Given the rapidly improving quality of Modine’s business and improving growth prospects, a valuation of 27 times expected earnings for the next twelve months does not seem surprising. In two years, the shares will be valued at 23 times expected earnings per share.

However, the valuation, as well as the hopes of the company’s elite backers, depends on Modine’s continued transformation and the sustainable nature of the improvements. Before the 80/20 strategy was unveiled two years ago, the shares were valued at less than five times earnings. Because part of the revaluation comes down to excitement about AI, if current data center spending declines, so will the stock price.

Source: FactSet. EPS = earnings per share. Forecasts based on the next 12 months.