It has been almost two years since I last wrote on Acuity Brands (NYSE:AYI), and in that time the company has seen only the barest recovery in residential and commercial construction, the acquisition of a major competition by a large conglomerate, and the advancement of LED lighting as a more feasible alternative. It is this last item that is likely to be the biggest driver for Acuity, as a switch to more efficient LED lighting could stimulate significant sales. As often seems to be the case with Acuity shares, though, it seems like investors are already well ahead of curve on this name.
Fiscal Q2 Results Meet The Grade
The market liked what it saw in Acuity's fiscal second quarter results, as the shares were up more than 6% and hit a new 52-week high in intraday trading.
Revenue rose 6%, surpassing the top end of the analyst estimate range and beating the average estimate by about 4%. LED sales more than doubled and now make up 15% of sales, which does also give some indication of the generally sluggish state of the lighting market.
Margins were okay, but requiring a little explanation. Due to a plant closure, the GAAP numbers are not necessarily the most accurate representation of results. On an adjusted basis, though, gross margin declined a scant 10bp, while adjusted operating income rose about 6%. On that adjusted basis, Acuity met the Street's $0.62 estimate, but clearly did not outperform on margins (as witnessed by the strong revenue beat, but missing the top EPS estimate of $0.72).
Can LED Really Drive A New Leg Of Growth?
While Acuity has nearly regained its pre-housing bubble revenue base, the reality remains that lighting is a tough business. Acuity's leading North American market share (about 15% to 20%) is all well and good, but it has never translated into particularly strong operating margins or returns on invested capital. To some extent, lighting is lighting – while factors like energy efficiency and appearance certainly matter, Acuity hasn't really carved out a defensible niche against rivals like Hubbell (NYSE:HUB.B), Eaton (NYSE:ETN) (which acquired Cooper), Philips (NYSE:PHG) and the like such that it can produce robust economic profits.
Now the hope is that LED lighting and lighting controls can improve this. LED lights offer substantial energy savings and a variety of attractive performance characteristics, but they have been quite expensive. The manufacturing efforts of LED producers like Samsung and Cree (Nasdaq:CREE) have brought costs down in recent years, though, and several governments have mandatory initiatives on the books to replace traditional lighting (like incandescent bulbs).
As commercial, industrial, and residential users switch to LED lighting, Acuity stands to gain. Not only do these lighting products carry high ASPs (though they're likely to decline as production costs improve), but solid margins as well. Of course, Hubbell, Philips, Siemens (NYSE:SI), and Cree are well aware of this too and all looking to make their own mark in the LED lighting fixture space. Once again, then, the challenge will be for Acuity to craft products that can support some sort of premium and/or attractive margins.
The Bottom Line
I think Acuity management's goal of getting half of its sales from LED lighting by 2015 is pretty ambitious. Likewise, I believe the company's growth expectations in lighting controls could be aggressive; while the company's products are generally well-regarded, the value-for-money equation is not also so favorable, and rivals like Lutron may be tough to beat. I would also argue that there is a risk of further consolidation in this industry – while Siemens wants out (looking to spin off or sell Osram), Acuity would not benefit from the entry of rival willing to invest resources in product development and distribution.
I'm still looking for decent growth from Acuity. I believe the contributions of LED lighting and revivals in construction will support 6% long-term revenue growth, with modest margin improvement potential leading to nearly 8% free cash flow growth. Those growth estimates only lead to a fair value in the neighborhood of $54 to $55 per share, though, and the company's relatively unimpressive historical ROIC don't argue for a premium valuation.
At the time of writing, Stephen Simpson did not own any shares in any of the companies mentioned.