Acuity Brands: Disappointing Long-Term Valuation

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About the company

Acuity Brands (AYI) is an innovative industrial technology company specializing in providing cutting-edge lighting solutions and advanced building management systems. Acuity Brands' clientele comprises electrical distributors, retail home improvement centers, electric utilities, national accounts, original equipment manufacturer ("OEM") customers and digital retailers.

The company operates through two reporting segments: Acuity Brands Lighting and Lighting Controls (ABL) and Intelligent Spaces Group (ISG). The ABL segment, which constitutes 95% of the total revenue, focuses on delivering exceptional lighting solutions to various commercial, architectural and specialty markets. On the other hand, the ISG segment, which contributes 5% of total revenue, is dedicated to offering intelligent products and services that enhance the efficiency, safety and environmental sustainability of various spaces.


Latest earnings results

Despite being a leader in its industry, Acuity Brands has faced challenges in recent months, leading to a decline of approximately 20% in its stock price since March 2023. These difficulties can be primarily attributed to weak demand and disappointing financial results in the second and third quarters of fiscal 2023. In its third-quarter financial results, the company revealed a 5.7% decline in revenues year-over-year, primarily driven by reduced volumes within the ABL segment. This decrease can be attributed to the normalization of lead times and the overall impact of prevailing macroeconomic trends.

However, amidst these challenges, Acuity Brands displayed promising signs of resilience and growth. The company's adjusted operating margin demonstrated impressive progress, increasing by 100 basis points year-over-year to reach 16.3% due to a combination of factors, including strategic price increases, enhanced productivity and reduced material costs.

In the ABL segment, sales declined by 6.7% year-over-year primarily due to decreases in OEM sales. However, the impact of these declines was partially offset by infrastructure projects within the direct sales network and strong performance in the retail channel.

During the fiscal third quarter, Acuity Brands introduced a significant addition to its service strategy called Design Select. This innovative offering aims to elevate services for the specification community by providing an easy and efficient way to select superior lighting and lighting control solutions with reliable service. Design Select encompasses 3,000 configurable products from Acuity's core families of lighting and lighting control brands, including Aculux, Gotham, Lithonia Lighting, nLight and SensorSwitch. This expansion in product options addresses important specification needs and solidifies Acuity Brands' commitment to meeting customer demands.

To further enhance its product portfolio, Acuity Brands continues to introduce new products. The Lumminis brand launched an in-line family of exterior luminaires designed for use in plazas and arenas. These luminaires offer exceptional flexibility, with each light module capable of rotating 355 degrees and being individually controlled. This feature allows installers to position the luminaires on-site, creating optimal illumination solutions tailored to specific environments.

Within the ISG segment, Acuity Brands is focused on expanding both its Distech and Atrius businesses. In the Distech business, the company aims to broaden its geographical reach and increase its market share in the built space. The recent acquisition of KE2 Therm in May 2023 further extends Distech's addressable market by allowing it to offer intelligent refrigeration control solutions. This expansion aligns with the growing demand for transcritical CO2 solutions in the refrigeration industry, which require precise digital controls for safety, efficiency and reliability while providing cost savings to customers.

In the Atrius business, Acuity Brands is building a robust data layer that connects to the cloud. This data layer, known as Atrius DataLab, serves as the foundation for a portfolio of Atrius applications aimed at automating the built space. Atrius DataLab captures and organizes data from building management systems in the cloud, creating a digital twin that can be utilized for historical analysis, real-time updates, and scenario modeling.


Revenue outlook

Looking ahead, I believe that revenue growth for the remainder of fiscal 2023 and the first half of fiscal 2024 should continue to be influenced by lead time normalization and a weak macroeconomic environment. This should be partially offset by pricing actions implemented in recent quarters. Acuity Brands' focus on investing in product vitality and service excellence could position it to gain market share in the medium to long term. Additionally, I believe the company should benefit from the U.S. Infrastructure Investments and Jobs Act as projects related to substantial funding start to be executed, supporting revenue growth in the coming years.


Margin outlook

In the third quarter of fiscal 2023, Acuity Brands achieved a remarkable improvement in its adjusted gross profit margin, which rose by 270 basis points year-over-year to reach 44.7%. The company successfully countered material, labor and other cost increases through effective pricing strategies and enhanced productivity. This accomplishment not only bolstered the gross profit margin but also had a positive impact on the adjusted operating margin for the quarter.

Looking ahead, Acuity Brands' investments in product vitality should play a crucial role in its pricing strategy, allowing the company to strategically price its products based on their value and improve the overall product mix. These efforts could contribute to sustaining and potentially increasing profit margins. Moreover, the moderation of inflationary cost pressures presents an additional opportunity for Acuity Brands to benefit from improved margins. As these cost pressures ease, the company should experience relief from escalating expenses, positively impacting its overall profitability. However, it is important to note that these favorable factors should be offset by volume deleveraging. While Acuity Brands continues to address market challenges and adapt to changing conditions, the impact of lower volumes on margins cannot be disregarded. Considering these factors, I believe that Acuity Brands' margins will likely remain relatively stable or exhibit slight improvement in the upcoming quarters.


Valuation

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In my DCF calculations, I am assuming revenue growth to be negative low single digits in 2023, given the normalization in lead time and weak macroeconomic conditions. Beyond 2023, I have assumed growth to be in the low-single digits, with a terminal growth rate in the low-single digits, as the company will continue to benefit from funding from the IIJA, improvements in service levels and product vitality. I used a discount rate of 7.69% and arrived at a fair value estimate of $165.45 for Acuity Brands, which is not much higher than the current share price of $157.57.


Conclusion

Acuity Brands’ revenue in the near-term should be negatively impacted by normalization in lead time and weak macroeconomic conditions. In the medium to long term, I believe it should benefit from improvements in service levels, product vitality and the projects related to government incentives. The margins should benefit from higher price realization, improvement in the supply chain and moderation in inflationary costs, partially offset by volume deleverage. However, given the unattractive valuation, I believe it is better to remain on the sidelines for now.


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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any ...

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