Wednesday, April 10, 2013

Acuity Brands Offers LED Lighting Growth

Anyone looking at the North American construction sector will be interested in what Acuity Brands $AYI had to say about the current state of markets. As a lighting manufacturer and distributor it is somewhat late cycle in the construction phase, but in general the commentary was positive and its revenues came in better than expected. So is this the green light for the construction sector and Acuity?

Acuity’s Q2 Results

As usual with companies that don’t give specific guidance, the results caused volatility in the share price. However the good news is that for the first quarter in three, the result was a happy one for existing shareholders. I’m a follower of this stock and have previously bought in after the last two ‘disappointing’ results.

If you want to see how Acuity’s previous results turned out (look out for the variance between analyst forecasts and the reported numbers) and get a primer in the trends in the company, there are articles linked here and here.

Fast forward to this quarter:

  • Q2 revenues of $486.7 million vs. analyst estimates of $468.5 million
  • Adjusted diluted EPS of 62c vs. analyst estimates of 62c

Revenues were way ahead of estimates after being significantly below the last time around. Meanwhile the EPS result implies that margins were below what the market had expected.

Indeed, while net sales were up 6.3%, volumes rose a more impressive 9%. The reason for the difference is that changes in the product mix (more lower margin renovation work) and increased sales of lower priced LED based lighting ensured that volumes rose more than sales.

In a sense the increased renovation work is a spill-over from the previous quarter (an indication that corporations will do anything they can to hold back spending during political uncertainty), and if it cost the company some margin expansion in the quarter then it is not unreasonable to expect margins to grow throughout 2013 as Acuity’s product mix moves back towards a more normal distribution.

The State of the Industry

The commentary around these results was pretty consistent with previous quarters. Last time around Acuity spoke of spending inconsistency and mentioned a ‘lull’ in no-residential construction while commercial and industrial customers were playing a ‘wait and see’ approach. My guess is that this was mainly with the kind of renovation work that bounced back in this quarter.

Furthermore and as noted earlier, lighting is relatively late phase in the construction cycle, and the sales process usually has a long gestation period. In other words if the industry is reporting good news in terms of building permits and billings then it will take at least 6-12 months before much of it even shows up with Acuity.

As ever let’s look at the Architectural Billings Index numbers from the American Institute of Architects, which certainly indicate stronger conditions for the industry...

…and while it’s true that residential is leading the way…

…investors need to understand that residential construction does tend to lead into increased commercial and industrial construction. It is the last two segments that are most important for Acuity, so clearly investors shouldn’t expect too much too soon. On the other hand the long term prognosis is looking good.

In the short term I note that Home Depot and Lowe’s Companies $LOW both reported broad based strength in their category sales. Lowe’s is in the middle of a product reset program ,but so far it is going very well and the company is undoubtedly being aided by favorable end markets. Amid the restructuring it has reported decent comparable same store sales growth in four of the last five quarters. Given that both Home Depot and Lowe’s sell Acuity products I think this bodes well for future performance.

While the home goods stores are good indicators of housing, I think a stock like Regal Beloit $RBC is worth following in conjunction with Acuity. Two thirds of its sales are in the US, and its sales split is roughly 39% residential and 61% commercial and industrial. Regal Beloit specializes in Heating, Ventilation and Air Conditioning (HVAC) machinery. I’ve covered the stock in an article here, and what Acuity investors need to focus on is that HVAC solutions tend to be late cycle (but before lighting) in the construction phase. In other words, if it is reporting good results than Acuity can expect conditions to be improving too. Indeed, it recently reported good results for HVAC in North America with the familiar commentary over some temporary weakness due to fiscal cliff worries.

Where Next for Acuity Brands?

Longer term I think margins will expand with increasing LED based sales (now 15% of total revenues from 13% in the last quarter) but as the management affirmed this will take time. LED lighting isn’t necessarily higher margin, but there is an opportunity to sell controls alongside new LED systems. LED lighting is going to lead to another wave of demand for LEDs and Cree $CREE has high teens revenue growth forecasts penciled in for the next few years. Indeed, Cree’s own lighting sales grew 14% in the quarter. These are clear signs that Acuity is right to carry on investing in LED based lighting.

As for the near to mid-term a recovering construction market and some margin expansion from a more favorable product mix going forward presents upside potential for Acuity. My one issue is that on 18x forward earnings I think the stock is pretty much fairly valued at this level. One for the monitor list.