LED Lights the Way as This Stock Surges
Lee is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The doom and gloom merchants have certainly got hold of the market in certain sectors and few more so than the commercial property sector. Unfortunately for the bears when a shorted stock reports results that more or less confirm its current outlook than the result can be a brutal swing to the upside. This was the case with Acuity Brands (NYSE: AYI) recent results and there is a lesson that can be learned from the 16% rise that followed. Incidentally, the stock slumped after the last results and there is an article on it linked here.
Simply put, the market has seen the recent declines in economic data and aggressively sold off certain sectors on any sign of industry weakness or negative commentary from a bellwether. In the case of lighting company Acuity Brands, investors saw the weakness in construction hiring in the payrolls numbers and the downturn in the Architecture Billing Index and then concluded that Acuity was headed for a big miss. They were wrong.
Regarding the Billing index, having been above 50 (indicating expansion) since November, it fell into negative territory in April and then accelerated the decline in May. Acuity stock has been weak ever since. Even the takeover speculation in the sector following the bid for its rival Cooper Industries (NYSE: CBE) wasn’t enough to dispel the gloom. So given the softness in non-residential construction spending, how has Acuity managed to increase sales and unit volumes by 6.4% and 5% respectively?
Lighting Gets Smart
It has been a long time coming but it seems that energy efficient LED based lighting is starting to grab market share from traditional lighting. It is not only Acuity that is seeing this. In April, its competitor Hubbell (NYSE: HUB-A) reported a 10% rise in sales and talked of strength in the industrial and utility markets. Interestingly, it argued that non-residential construction activity was soft but was offset by renovation and relighting projects of which LED lighting is a component.
Acuity confirmed this trend in its latest results. Essentially the company is diversifying away from its reliance on new non-residential construction and towards offering innovative renovation, lighting control and LED based solutions. It’s working.
LED based lighting now accounts for 10% of sales from 7% previously and Acuity is a market leader in digital lighting. Whilst LED solutions have profit margins similar to traditional lighting so no margin uplift here, it is the increase in demand which is allowing Acuity to drive sales higher irrespective of slow construction markets. Moreover, the North American renovation and relighting market is seen by market forecasters as growing in excess of the growth rate in new construction.
Another key driver is the convergence of lighting with controls. LED based lighting allows users to create a significant amount of customization and the increase in demand for LED’s will create a concomitant rise in controls demand. In addition, the two are converging. All of which is creating increased interest in Acuity’s products.
A Well Run Company
Acuity hasn’t been slow in reacting to softer construction markets over the last few years. It closed a plant in the US recently and downsized operations in Spain. Moreover its strategy of using agents gives it more flexibility to manage fluctuations with end demand. It also allows the company to expand geographic locations with more ease. Going forward, LED costs can be expected to abate but elements like higher rare earth costs mean that overall costs are likely to go up. Indeed, if we focus on what LED manufacturer Cree (NASDAQ: CREE) i saying that it is lighting that will lead demand for LEDs in future. This is important because it encourages companies like Cree to invest in developing new technologies for Acuity’s lighting solutions.
One potential source of worry for the sector is the continued moderation in public sector spending, however Acuity has limited exposure. Gross margin expanded in the quarter and the balance sheet is strong enough for acquisitions (a key part of strategy) and for buybacks. In other words, the management is wringing every bit of performance that it can from the company.
Where Next For Acuity Stock?
I think the risk/reward proposition is favorable for Acuity. Construction markets remain weak but it managed to achieve 5% unit volume growth in this quarter, so there is ample scope for more growth if and when US construction activity picks up.
Moreover, the company has just generated $157m worth of free cash flow in the last year. This equates to over 6% of the current Enterprise Value (EV) and this is in soft end markets. Analysts have 20% EPS growth pencilled in for the next two years and if Acuity hits these numbers the evaluation will likely be higher. I think the trend towards LED lighting and control is an exciting secular one and, it is reasonable to expect it to continue as technology improvements and market awareness add to its competitive advantage.
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