Sunday, November 25, 2012

Is Acuity Brands a Stock Worth Buying?

Lighting company Acuity Brands (NYSE: AYI) announced earnings recently and missed estimates. As usual, the market greeted this sort of news with a knee-jerk reaction sell off—but is this a buying opportunity? I think so, and will look to go back into this stock in due course.

 Acuity’s Core Profit Driver

Let’s not kid ourselves: this stock is primarily a play on the North American property construction market. Acuity has been active in diversifying its profits away from new builds, but its core market remains commercial and industrial lighting. And the market didn't like Acuity’s commentary on the North American market.  Acuity argued that it had “experienced a slowdown in the rate of growth over the past few months.”  Worrying?

Not really. It is pretty much consistent with what the Architectural Billings Index has been reporting.

Acuity’s results were for the end of August, so with most of the quarter being weak and the trend deteriorating since March it is not surprising that the numbers missed estimates. As for the commentary, what else would you expect the company to say?

As you can see above, the recent trend looks like a linear uptick, and this is a cause for optimism. Another positive point is that all three segments within the property constructions sector are improving:

In a sense this is normal, because the mild winter pulled forward some construction activity and the hurricanes last year also created some artificially strong activity. However, these factors have created weaker results for this quarter.  I think the underlying picture is good here and I’m not that concerned.

LED Lights the Way?

With technology improvements and the increasing commoditization of pricing, LED lighting is becoming a truly viable solution for the construction industry. Indeed, I’m intrigued by what key manufacturer Cree (NASDAQ: CREE) is saying. It sees strong growth from its lighting division and is innovating in the development of LED solutions. Of course, the company is better known as an LED manufacturer (Acuity uses them) and with demand weak elsewhere in LED land the cost and quality advantages for Acuity should be getting better.  Indeed, this quarter saw LED-based sales increase to 12% of sales, from 10% previously.

Just as with Cree, I expect Acuity’s LED-based to sales to spur growth, but not only with lighting. I think lighting controls are going to be an ever more important source of revenue. As LEDs offer so much more functionality the need to integrate them with control systems will increase; and these solutions come with a higher value added ticket price. In other words, Acuity & Cree can expand margins.

Housing Driving Growth

Going back to the last chart, it’s clear that the residential construction market is getting stronger. If we listen to Home Depot  (NYSE: HD) and accept its argument that US housing is somewhat of a ‘sweet spot’ in the economy, then housing related spending  is on the up. For Home Depot this means it can start to expect to separate its growth trajectory from US GDP, and I think the same applies to Acuity.

Even though residential only makes up 10% of direct revenues for Acuity, much of construction activity is related to residential growth. You can’t build new housing without building infrastructure around it, and the different parts of construction spending do tend to correlate. I like Home Depot as a housing play and think Acuity is –although somewhat indirectly- also a housing play too.

Incidentally, both Home Depot and Lowe’s (NYSE: LOW) distribute Acuity’s products.  While Lowe’s has been weak recently, it has pushed sales of Osram’s Sylvania LED system. Lowe's may be having execution difficulties, but it is not because of LED sales.  This sort of marketing push is great for the industry because as soon as neighbors see each other buying LED lights, they will surely not want to be left out.  The good news is that Lowe’s is not the only company doing this.

General Electric and Philips Electronics (NYSE: PHG) are also aggressively marketing their LED lighting solutions. Philips sees itself as the number one player in LED lighting and its market share in the segment exceeds its share in conventional lighting. LED lights already make up over 18% of its total lighting sales. With heavyweights like this promoting LED lighting, every company should benefit, as the industry is in its infancy.

Buying Opportunity?

I think so. Acuity is a well-run company that consistently has a high income to cash flow conversion rate. Gross margins and adjusted operating margins are expanding, and I like the long term drivers.  Yes, the commentary on why Acuity missed estimates wasn’t great, but I have tried to demonstrate why there’s still plenty of growth to come for the company. The underlying picture looks positive, and with a “benign” cost environment I expect margins to improve with volumes and LED lighting sales.

Acuity trades on a FCF/EV evaluation of 5.3% and a PE of 22, with EPS growth forecasts of 18% for next year.  With strong financials and a bearish backlash for missed earnings, now looks like a buying opportunity to me.

No comments:

Post a Comment