niphon
Investment Thesis
Acuity Brands, Inc. (NYSE:AYI) recorded healthy sales volume and pricing growth in its last quarter, which helped it post double-digit revenue growth in the quarter. While there are concerns regarding macroeconomic slowdown, the company’s higher-than-usual backlog, easing supply chain, investment in product vitality which is helping it improve price/mix, should support revenue growth. Further, the company is expected to benefit from the $1.3 billion federal infrastructure investment bill. The company is making strategic acquisitions to support technology advancement and create more valuable products to surpass their competitors, which should also aid revenue growth. Recent price increases along with easing supply chain and productivity initiatives are expected to help the company’s margins. The stock is trading at a discount to its historical levels. Given its good revenue growth and operating margin prospects and low valuations, it is a good buy at the current levels.
Acuity’s Last Quarter Earnings
Earlier this month, Acuity Brands reported better-than-expected results. Net sales of $1.1 billion (vs consensus estimate of $1.08 billion) were 12% higher than the prior year, with both the ABL and ISG business segments contributing to the growth. Sales in the ABL segment of the company stood at $1 billion, an increase of 11% year-over-year, whereas net sales in the ISG segment were $61 million, 22% versus the prior year. The company delivered gross profit of $462.5 million and adjusted operating profit was $170 million. Adjusted operating profit increased 9% YoY due to the increased net sales while adjusted operating margin fell 50 bps from 15.8% in Q4 2021 to 15.3% in Q4 2022, due to cost inflation and supply chain inefficiency. Adjusted diluted earnings per share were $3.95 or up 21% over the prior year, which was better than consensus EPS estimates of $3.61.
Revenue Outlook
During the initial phases of COVID-19, AYI faced stiff competition due to aggressive pricing policy by its competitors, which pressured AYI’s pricing as well and resulted in negative price/cost. This can be evidenced by a 5% decrease in net sales for Q1 2021 year-over-year, which includes a 4% decrease due to change in product price and mix and a 1% decrease in sales volume.
To address this problem, Acuity Brands, Inc. has implemented its product vitality and service initiatives. A product vitality initiative combines new product introductions with improvements to their existing portfolio to ensure that the products are more valuable to customers. This allows the company to raise the price of its differentiated products.
A good example of the success of this initiative is its Contractor Select business, which is a collection of the most important everyday lighting and lighting control products. AYI has done and continues to do significant work on product vitality in this portfolio and, according to management, this has led to impressive results and Contractor Select is growing faster than their broader portfolio. A further expansion of this initiative in other business categories of AYI should benefit them through improved and higher-valued products in the market. In addition to product vitality, management also plans to improve service quality to drive sales and pricing looking forward.
In addition to organic growth initiatives, the company is also focusing on inorganic growth. The capital allocation strategy of AYI has prioritized investments for growth in their current business, investing in acquisitions and maintaining dividends. Last year, AYI acquired the OSRAM DS business and added it to its eldoLED product family, which is a part of the lighting segment. The acquisition is contributing to the company’s goal of more technology in its luminaires, expanding its OEM channel and taking greater control of their electronic supply chain. This focus on technology will allow them to continue to grow over the next 3-5 years and lead on the technology curve, which will help improve AYI’s portfolio over time. This also gives them more control over their product life cycle management and their product development cycle.
An effective capital allocation on technological advancement should also help the company make progress on its product vitality strategy and result in increasing the value and profitability of its products over time. In the last fiscal year, AYI had implemented seven price increases helped by its differentiated and technology-driven products, which illustrates the success of this strategy.
From the last few quarters, supply chain is one of the key headwinds in revenue growth of AYI. Longer lead time due to transportation cost & other freight cost is leading to higher than usual backlog and lower revenue growth. As global supply chain conditions improve, it should also benefit the revenue in upcoming quarters.
Looking forward, the company’s product vitality and pricing increases, higher than usual backlog and easing supply chain should help revenue growth. There are certain demand drivers in place like the $1.2 trillion infrastructure bill passed by the federal government, which should help the company’s non-residential construction business. While the new residential construction market is facing a headwind due to a high interest rate environment, I believe it can be offset by increased demand in the non-residential sector as well as strong demand in the renovation and retrofit market. So, I believe the company’s revenue growth can continue in the coming years.
Margin Outlook
One of the major headwinds AYI has faced on the margin front in the recent quarters is supply chain constraints. Despite the price increase at the end of the third quarter, operating margin fell 50 bps Y/Y in Q4 2022 due to increased transportation cost, freight cost, and other supply chain inefficiencies. To overcome these headwinds, AYI had prioritized 3 key activities:
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Investing in supplier relationship to procure as much of the available component supply as possible
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Empowering their teams to secure components in open market
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Engineering products to available components
AYI has recently introduced a “7-shared values” program including values like integrity, owner’s mindset, community, time & curiosity, which will act as a decision-making framework that empowers their associates and allows them to operate efficiently with greater distribution of responsibility and accountability. The Global Career Architecture project is also enacted by the company to acquire a more efficient and talented workforce in the upcoming years.
Implementing these policies, along with its price increase strategy to offset cost inflation, should help the company increase its operational efficiency. This will result in improved operating margins for Acuity Brands Inc in the coming years. Further, supply chain conditions are also improving, which should also be beneficial for margins. So, I am optimistic about margin growth prospects in the coming quarters.
Valuation and Conclusion
AYI Stock is currently trading at 12.50x FY23 consensus EPS estimates of $13.70. This is a discount versus its historical 5-year average forward P/E of 14.86x. While I understand macroeconomic concerns, I am optimistic about the company-specific initiatives to improve revenue and margins. Further, higher than usual backlog, easing supply chain and upcoming infrastructure stimulus spending should offset some of the macroeconomic headwinds. I believe the stock offers good risk-reward prospects at the current levels and have a buy rating on the company.
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