Forbes magazine ran an article on November 22 in conjunction with DividendChannel.com highlighting the fact that Acuity Brands (NYSE:AYI) director Norman Wesley acquired 3,500 shares of the company on the open market on October 25 for $45.42 a share. The article went on to suggest that this type of insider buying is a good indication the individual believes the stock is undervalued. Generally, that's true; however, in this instance, Wesley was buying in order to fulfill his stock ownership requirements as a director. That being said, Acuity's stock is down 22.6% since July 1, when Investopedia's Stephen Simpson suggested its stock wasn't undervalued. It is now.
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Acuity's year ended August 31 and its revenues of $1.8 billion and net income of $105.5 million was its second best yearly performance since it spun-off Zep (NYSE:ZEP) in October 2007. Revenues grew 10.4% year-over-year, operating profits 19.7% and diluted earnings per share by 34.4%. In the fourth quarter, despite gross margins declining by 110 basis points to 40.4%, operating margins actually increased by 40 basis points to 11.2%. On a non-GAAP adjusted basis, operating margins dropped 30 basis points. For the year, operating margins increased 80 basis points to 10.5% but only increased 30 basis points on a non-GAAP adjusted basis. However, as long as the company can continue to grow revenues at 10% a year or more and improve operating margins by 20 to 50 basis points annually, there will be plenty for shareholders. In 2011, Acuity paid out 52 cents a share in dividends or 21% of earnings. That's a very conservative amount. In the last five years, it's never paid out more than 29% of earnings for dividends. (To know more about spinoffs, read: Cashing In On Corporate Restructuring. )
In July, Acuity's stock was trading 10% off its 52-week high while two of its peers, Cooper (NYSE:CBE) and Hubbell (NYSE:HUB.B), were both 20% of their 52-week highs. Fast-forward five months and Acuity is now 30% off its high while Cooper and Hubbell are off 25.8 and 19.2% respectively. Despite delivering reasonably good fourth quarter results, Acuity went backwards while its peers stayed where they were. This hardly seems fair, but I guess investors fear Acuity's lack of diversification beyond lighting. I see absolutely the opposite. Too many companies diversify here and there without any real focus. As I wrote in an April 2008 article discussing the Zep spin-off, unrelenting focus usually wins in business. As the population ages, good lighting becomes even more important, whether at home or in the office.
Year-to-date, Acuity is down 24.6% compared to negative 9.37% for Cooper and positive 12% for Hubbell. Unless it has a giant recovery, its two peers will easily best it in 2011. However, since 2002, Acuity has outperformed both companies in six out of 10 years. Long-term, it's not hard to spot the winner.
A total of 13 analysts estimate Acuity's earnings-per-share in 2012 will be $2.94 and nine analysts estimate 2013 earnings of $3.53 a share. That's a 2013 forward P/E about 12.9, 30% lower than its five-year average of 18.3 times. That's hard to fathom when its earnings are expected to grow 14.3% annually over the next five years. Now, back to its peers for a moment. Acuity's cash return (free cash flow less interest expense divided by enterprise value) according to Morningstar is 6.9%, slightly less than Hubbell's at 7.1%, but much higher than Cooper at 3.9%. However, using the trailing 12-month figures from Morningstar's own financial information, Acuity's is 8.7% compared to Hubbell at 8% and Cooper's is the same at 3.9%. Acuity generates more free cash as a percentage of enterprise value than either of its peers, while also outperforming them in terms of total return most years and yet has a lower valuation. Eventually the markets will rectify this mispricing. (For additional reading, check out: Value Investing Using The Enterprise Multiple. )
The Bottom Line
At $56 in July, an argument could be made that Acuity's stock was trading at fair value. Today, it's anything but fair. Time to go shopping.