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Market Has Lacked Visual Acuity

- By Mark Yu

Shares of Acuity Brands (AYI), a Georgia-based company now worth $7.5 billion, have been trashed by the market recently. It reported its second quarter and first half fiscal 2017 results.

Thereafter, Goldman Sachs (GS) downgraded the company's shares to neutral and lowered its share price target to $186 from $256 - a 27% correction. According to The Street, Acuity Brands missed analysts' earnings estimates for the third straight quarter. Its shares fell 14.7%.


Earnings performance

For the six months of operations that ended in February, Acuity Brands reported 9.3% sales growth to $1.7 billion and 11.3% profit growth to $149 million - 9% margin compared to 8.8% the year prior period.

As observed, the electronics maker recorded a 140% jump in "Special Charges" to $1.2 million in relation to organization streamline activities including recent acquisitions integrations. Acuity Brands also exhibited a 305% increase in "Miscellaneous Expense" to $7.3 million for the period.


"Acuity Brands continued to deliver sales growth while initial industry data suggests that the North American lighting market declined modestly during our fiscal second quarter, reflecting continued weakness in smaller, short-cycle projects. Additionally, sales in certain international markets, including Europe and Mexico, were down year over year, reducing our overall net sales by approximately 1 percentage point compared with the year-ago period.

"Our adjusted gross profit margin of 41.7% declined 180 basis points compared with the prior year, primarily due to higher manufacturing expenses resulting from increased wages and benefits, inbound freight costs and quality costs.

"Like last quarter, we carried a higher manufacturing cost structure into the quarter in anticipation of servicing a greater level of demand than occurred. This higher cost structure negatively impacted both gross profit dollars and margin. Adjusted selling, distribution and administrative (SD&A) expenses declined 80 basis points year over year and represented 26.3% of net sales in the second quarter of fiscal 2017 compared with prior year's 27.1%.

"Even though demand was subdued, we have continued to invest in areas we believe have longer-term growth potential. These areas include, among others, the expansion of our lighting and building management solutions portfolios as well as our Internet of Things software platform that provides customers with a smart infrastructure which enables endless possibilities to enhance the utilization of their space through better human interaction and greater asset and employee productivity.

"Additionally, we continued to add associates to support these intelligent Tier 3 and 4 solutions. The cost of these investments was largely offset by lower variable incentive compensation, which yielded a modest $1.0 million year-over-year increase in adjusted SD&A expenses. Our adjusted operating profit margin of 15.4% declined 100 basis points compared with the prior year." - Vernon J. Nagel, chairman, president and CEO of Acuity Brands



Total returns

This year Acuity Brands performed poorly having 26.13% total loss compared to the Standard & Poor's 500 index's 5.7% total gains, according to Morningstar data. In the past five years, the company still outperformed the broader index with 25% compared to 13.4%.

Valuations

Acuity Brands is mildly undervalued compared to its peers. According to GuruFocus data, Acuity Brands had a trailing price-earnings (P/E) ratio of 24.6 times vs. industry median 20.8 times, a price-book (P/B) value 4.3 times vs. 1.7 times and a price-sales (P/S) ratio of 2.2 times vs. 1.1 times.

Acuity Brands also had a trailing dividend yield of 0.3% with an 8% payout ratio.

With average 2017 sales and earnings-per-share expectations, the company had forward P/S and P/E multiples of 2.1 times and 20.3 times. In combination, these forward multiples are 40% lower than the past three-year averages.

Acuity Brands

According to filings, Acuity Brands is the parent company of Acuity Brands Lighting and other subsidiaries.

Acuity Brands is one of the world's leading providers of lighting and building management solutions for commercial, institutional, industrial, infrastructure and residential applications throughout North America and select international markets.

The company's lighting and building management solutions vary from individual devices to intelligent network systems. Individual devices include luminaires, lighting controls, lighting components, controllers for various building systems (including HVAC, lighting, shades and access control), power supplies and prismatic skylights

Acuity Brands' lighting and building management solutions are marketed under numerous brand names, including but not limited to Lithonia Lighting(R), Holophane(R), Peerless(R), Gotham(R), Mark Architectural Lighting(TM), Winona(R) Lighting, Juno(R), Indy(TM), AccuLite(R), Aculux(TM), Healthcare Lighting(R), Hydrel(R), American Electric Lighting(R), Carandini(R), Antique Street Lamps(TM), Sunoptics(R), RELOC(R) Wiring Solutions, eldoLED(R), Distech Controls(R) and Acuity Controls(TM).

Acuity Brands' principal customers include electrical distributors, system integrators, retail home improvement centers, electric utilities, lighting showrooms, national accounts and energy service companies located in North America and select international markets serving new construction, renovation and maintenance and repair applications.

In fiscal 2016, sales originated in North America accounted for approximately 96% or $3.6 billion of net sales. According to the company, no single customer accounted for more than 10% of net sales in fiscal 2016, but it mentioned Home Depot (HD) to represent 11% or $298 million of total sales in fiscal 2015.

The company serves an approximate $19 billion North American lighting and building management solutions market as of fiscal 2016.

Acuity Brands also has one reportable segment serving the North American and select international lighting and building management markets.

In review, domestic sales grew 19.5% in fiscal 2016 and delivered 14.7% income before provision for taxes margin compared to 13.4% in 2015.

Meanwhile, international sales grew amazingly with 41.5% growth to $363 million and registered an income before provisions margin of 3.8% compared to 5.5% in 2015.

In the past three years, Acuity Brands logged sales and profit growth and margin averages of 16.4%, 31.7% and 8.1%.

Cash, debt and book value

As of February, Acuity Brands had $463.2 million in cash and cash equivalents and $356 million in debt leading to a debt-equity ratio of 0.20 times vs. 0.24 times a year prior.

Of Acuity Brands' $3 billion assets, 45% were labeled as goodwill and intangibles. The company also had a book value of $1.8 billion compared to $1.7 billion the year prior.

Cash flow

In its recent six months of operations, Acuity Brands cash flow from operations declined by 40% to $71.6 million. Despite the steady profits, the company recorded more cash outflow from investment in the unconsolidated affiliate, deferred income taxes, inventories, accounts payables and other current liabilities.

Capital expenditures were $35.8 million leaving Acuity Brands with $35.8 million in free cash flow compared to $75.7 million in the year prior.

Further, the company allocated $11.5 million in dividends and $400,000 in share repurchases representing 33% of free cash flow. In the past three years from 2014 to 2016, Acuity Brands provided 10% of its free cash flow on shareholder payouts on average.

Acuity Brands also took in $9.4 million in long-term debt issuance, including proceeds from stock option exercises, tax benefits from share-based payments and other financing activities.

Conclusion

Certainly, Wall Street estimates must be met in order to gain much higher appreciation. Taming down of excitement led by leading investment banks could definitely show vulnerability in any company's shares.

Meanwhile, Acuity Brands exhibited a stellar performance despite the former assault. The light company, in fact, delivered a strong 8.99% profit margin in the recent six months of operations compared to a three-year average of 8.13%.

The company nonetheless has to work on its heavily blue-sky inflated balance sheet, and so much fewer payouts that could have been provided to loyal shareholders.

Despite the dire and less appealing recommendation provided earlier, average price target by ten analysts or Acuity Brands is at $223.7, a 31% upside.

Using five-year sales growth averages and asking for a 30% margin indicated a value of $7.24 billion or $165 a share.

In summary, Acuity Brands is a buy with $200 a share target price.

Disclosure: I have shares in Acuity Brands.

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This article first appeared on GuruFocus.