Description

Thesis

Acuity Brands is a very good business available at a very reasonable price. It is a market leader in the stable lighting and control industry. AYI has excellent returns on invested capital and a management that has been and will continue to return substantial amounts of capital to shareholders via buybacks. This above average company is available for a below market multiple of NTM EV/EBITDA 9.5 versus the market at 12.8 and peers at 14. This is a boring business routinely posting good numbers and beating their earnings estimates.

Company Profile

Acuity Brands is a lighting and lighting control company serving the North American market. They make all sorts of light fixtures (which they call luminaries), lighting controls, and lighting components. They also provide systems to control and manage the lights, sensors, and HVAC of large facilities. In plain speak their products would go into a newbuild or renovated school, airport, or warehouse: the lights that light up, the fixtures that hold them, the controls that control them, the sensors that inform them. They might also supply (through their Intelligent Spaces Group) systems that would let the owners control lights and other systems, monitor their facility, and track their greenhouse emissions.

The company primarily sells in the North American market (98%, with 87% in the US) and is 50/50 new construction vs renovation. 85% of their revenues are non residential. In Lighting they claim to be number one in commercial, outdoor, industrial, and life safety and number four in residential. They sell both commodity and specialty products. In Lighting Controls they are number one in commercial lighting and indoor positioning. They have 22 manufacturing facilities (again mostly in North America) and 12,000 associates. Acuity references a $20B annual addressable market in North American lighting and controls (compares to $4B in FY 22 revenue).

Acuity places a large emphasis on their sales channel where they target independent sales agents, electrical distributors, and retailers. A key strategy has been to increase service levels to distributors. End clients are often architects, builders, and contractors. They have an extremely large number of brands (shown below) and products, with about 75 new product families coming to market each year.

Acuity operates in two segments: Acuity Brands and Lighting Controls (ABL) and Intelligent Spaces Group (ISG)

Acuity Brands and Lighting Controls represents the great bulk of their business with $3.8B of revenue in fiscal 2022. This segment is slower growing and relatively lower margin (near term guidance of low to mid single digit revenue growth and mid teens adjusted operating margins).

Lighting Brands

Controls Brands

Components Brands

Intelligent Spaces Group is a faster growing but much smaller part of Acuity’s business, and therefore somewhat immaterial to the company’s overall results. Revenue in fiscal 22 was $216MM (5% of total). They’re guiding towards low to mid teens revenue growth and adjusted operating margins in the higher teens to low twenties. One focus is Artius which customers can use to manage utility bills, reduce environmental footprint, and track and manage assets. Distech Controls is a leader in building automation and HVAC (air control valves, connected thermostats, building intelligence etc.).

Indicators of Outstanding Business

This business has many of the qualities we look for in a high quality operation that one can hold for the long term.

Excellent ROIC

Most importantly, when adjusting for the excess cash on the balance sheet and removing non-tangible items from past acquisitions, Acuity has maintained an ROIC consistently above 30%. This company has a history of doing bolt on acquisitions and so it is appropriate to all look at this calculation with goodwill and other acquisition related assets and charges in the ROIC equation as well. This “acquisitive ROIC” (which is a little less meaningful as previous management executed the vast majority of acquisitions) is still in the mid teens, which is still above average.

Consistent and Growing GAAP Profitability

No large one-time or consistent charge offs have interfered with adjusted earnings becoming real earnings.

Free Cash Flow

Over the past ten years, on average 98% of earnings have converted to Leveraged FCF (recent years have been above 100%). Both leveraged and unleveraged free cash flow yields are around 6% for the last three years, representing an attractive valuation for a stable and growing company. Operating cash flow consistently exceeds capex by a large margin.

Capital Allocation and Capital Return

In recent years, management has returned most of the excess free cash flow to shareholders in the form of buybacks, which we find attractive since during that period Acuity has been relatively cheap. They’ve been buying back about $500MM in shares per year, or about 20% of the company since 2020 at an average price of about $140. 

When adding these buybacks and the small dividend (and subtracting share based compensation), shareholders received an 8.4% shareholder yield in the last twelve months. This has been accomplished with a slight increase in debt, but management has a lot more room on the balance sheet to continue buybacks in excess of FCF over the next few years if valuation does not increase.

Strong Balance Sheet

Acuity has a strong balance sheet with net debt of only 0.5 to EBITDA which compares favorably to electrical component and equipment peers at around 1.8x.

Revenue Growth

Through its history, AYI’s revenue growth has been in excess of GDP but without many material acquisitions in recent years it had dipped to mid single digits. They are guiding to 6% revenue growth for the year ahead.

Stable Business

No commodity exposure or risk of sudden obsolescence or catastrophic event. 50% exposure to remodel/retrofit helps smooth the impact of the commercial building cycle.

Factors Affecting Future Performance

The essence of this pitch isn’t an attempt to judge the immediate future, but rather to point out that Acuity is a good company available at a cheap price. Nevertheless, here are some positive and negative trends/factors affecting the business.

• Green trend / retrofitting - This is a “super trend” that the company talks about extensively that mostly consists of retrofitting existing space for more energy efficient lighting and using sensors to light less / only when needed. However, while this is a reason sales can grow in excess of new construction / simple replacement, it is one that has been going on for a while that I wouldn’t expect to materially accelerate results.

• Controls - Installing additional controls in luminaries is another trend increasing overall spend in the space, as more control than simply “on-off” continues to become more popular. Everything is also trending towards wireless controls which again represents additional spend.

• Healing of supply chains - This is both good and bad for AYI. With supply chains healing, Acuity can do less anticipatory ordering and improve their capital efficiency in coming quarters. Unfortunately, AYI’s customers will probably do the same and be working their own excess inventory so there could be a slight dip in new orders.

• Chips - The increasing availability of chips should remove a materially inflated cost for Acuity, and one that they had raised prices to offset.

• Infrastructure - Acuity is well positioned to capture some of the coming legislatively-driven increase in infrastructure spending, which should be a multi year trend.

• Slowing home sales - This should only be a minor headwind as the company is 85% non-residential.

• Onshoring- They are ahead of the curve here as only 20% of their product comes from Asia, with most of the remainder being in Mexico.

• Potentially slowing commercial construction - This is the big one and potentially the most important factor affecting Accuity’s performance. Large changes in WFH habits will certainly hurt office construction and is something to watch. The leading AIA Architecture Billings Index is indicating a slight contraction at 49.3 in January, though that represents an improvement over the last two months.

Return Expectations

In general, owning good companies at cheap prices should produce favorable returns over the long run. Forward PE is 14 versus its long term average of 17.6 and EV/EBITDA is 9.5 versus its long term average of 10.5.

Revenues growing at 7% (assuming no lift from acquisitions), margins staying flat, share repurchases decelerating to 4% a year, slight multiple expansion to 17 PE (still below long term average) can result in a nice high teens IRR or stock price of $250 in 2024.

Catalyst

Continued solid performance and share buybacks.