Brands Acuity, Inc. (NYSE:AYI) is one of the leading technology companies in the industrial sector. The company specializes in providing advanced lighting solutions and designs smart spaces that help customers reduce costs. AYI operates under two reportable segments: ABL segment and ISG segment. The company highlighted a few acquisitions last year such as ams OSRAM and Rockpile Venturesand from there, we’ve seen a positive revision to its revenue consensus for the next fiscal year, which is currently at $3.88 billion compared to $3.45 billion in April of last year.
However, AYI is operating in a tougher environment than ever, including rising 10-year yields, rising mortgage rates and rising input costs for steel and aluminum. This resulted in a decline in operating margin of 11.29% and a net margin of 8.28% this Q2 2022. Moreover, its short-term risks on its declining profitability are also triggered as the company generated a ratio debt ratio of 0.26x compared to its 5-year average of 0.22x. Although the company remains liquid, with cash flow down $43.6 million in the last quarter and an unfavorable valuation, I think AYI is heading for a new low, which could provide an opportunity to favorable decline.
Released a solid top line
AYI posted strong total revenue of $909.1 million in the second quarter of 2022, up 17.06% from $776.6 million in the same quarter last year, as the management sees a continued recovery in demand and positive results from its recent acquisitions. Both of its segments saw positive year-over-year growth this quarter, with the ABL segment generating $863.1 million, up 17% from $736.8 million in the same quarter last year. last, and the ISG segment generating $50 million, up 15% from $43.3 million. Last year. However, looking at its annual figure, we can see that its main revenue contributor, the ABL segment, is still below its pre-pandemic level of $3,548.40 million recorded in the last fiscal year 2019.
This is a bit of a concern, especially with its workforce increasing to 13,500 from 12,000 recorded in fiscal year 2019. However, management provided an update on improving its product portfolio , which could help break ABL’s current revenue trend.
Finally, as I said last quarter, our engineering teams continue their Herculean efforts to redesign products based on available components. At the same time, these teams have also succeeded in introducing approximately 220 new or significantly improved lighting and lighting control products over the past two years. Source: Q2 2022 earnings call
Unlike its main revenue contributor, its space segment, which represents 5% of its total revenue, is showing strong momentum thanks to its recent acquisitions.
According to management, they are experiencing continued growth through one of their brands, Distech One, securing important projects.
During the last quarter, Distech One completed projects in North America and Canada and won major projects in key verticals, including education, retail, infrastructure and data centers. data. Distech is now a key vendor for two of the largest cloud providers. We also continue to develop the Atrius platform, including progress on the Atrius build outlook, and plan to expand the portfolio over time. Source: Q2 2022 earnings call
On the contrary
Along with lower operating and net margins, AYI reported lower operating cash flow of $43.6 million, down from $88.7 in the same quarter last year. . This is due to their investment in inventory, which hit a record high of $546.8, in an effort to address their current supply chain issues. Consequently, this caused its cash conversion cycle to swell by 63 days above its 5-year average of 55 days and its FCF margin down 3.17% from 10.16% vs. same quarter of last year. While this inefficiency, in my view, is only temporary, this working capital settlement could consume budget allocated for share buybacks and potential expansion in the future. Indeed, there is a risk of tighter competition with GE current the acquisition of Hubbell’s Incorporated commercial and industrial (C&I) lighting business, which could potentially gain a share of the company’s TAM for $20 billion. This is of particular concern for the company, as it has no significant mergers and acquisitions this first half of 2022.
Looking at the chart above, we can see that the current sentiment of AYI’s multiples varies from its P/S ratio to its P/CF ratio. While its P/S ratio of 1.64x is above the average of its peers, it is slightly below the 5-year average of 1.64x. Moving on to its P/E ratio of 17.81x, it is considered cheap compared to the average of its peers, however, it appears to be just enough valued compared to its 5-year average of 18.87x, despite a significant drop in price. Additionally, its two EV/Sales ratios of 1.57x and EV/EBITDA of 10.32x tell the same story with their respective 5-year averages of 1.60x and 10.40x that the company does not offer a significant discount. at today’s prices. Finally, AYI has generated a worrying P/CF ratio of 18.28x, which is currently expensive compared to its peers’ average of 15.49x and the 5-year average of 13.83x.
Waiting for a better brand
When I looked at AYI’s intrinsic value based on its projected future cash flows, it appears to be due to a correction; However, when I incorporated a simple relative valuation and averaged the two valuation metrics, I found that the stock had very little upside potential at today’s price.
The image above represents my assumptions that I used to complete my DCF model. My model assumes a 5-year CAGR growth of 4.24%, based on analyst estimates. I started my estimated operating margin with stable growth and reached 14.1% at the end of the model. Although the company invests heavily in its inventory, I changed the trajectory of its changes in working capital, as shown in the image above, and used its FY 2021 figure to project a change in net working capital of -115 million by the end of the model. Despite generous assumptions, I found adverse sentiment using DCF analysis due to rising yields which affected my WACC calculation. However, AYI is pursuing an M&A opportunity and with its current market leadership and strong partnerships with large companies such as Microsoft (NASDAQ:MSFT), I believe a significant acquisition will alter the revenue trajectory, rendering this model obsolete.
The struggles continue
As shown in the chart above, AYI is currently testing its multi-month support trendline. I anticipate a breakout of its current sentiment from its valuation, providing an opportunity to buy AYI at a discount. Additionally, the price has already broken above its 50-day simple moving average, and a bearish crossover of the 20-day SMA could indicate short-term bearish price action. I believe that below $160 investors and traders will provide a reasonable entry point and favorable margin of safety at the $138 level.
AYI is showing temporary headwinds affecting its current valuations. Despite the bearish catalyst mentioned in this article, management continued to reassure investors that their capital allocation strategy prioritizes horizontal and vertical mergers and acquisitions and shareholder value appreciation through dividends and share buybacks, as detailed below.
…our capital allocation priorities are quite simple. First, we want to grow the business, we already have two, we want to grow the business through acquisition, both investing in our current business, lighting and spaces, as well as adding additional businesses over time. time. The third is to maintain our dividend. And then the fourth is when we see an opportunity to create permanent value through stock buybacks. Source: Q2 2022 earnings call
In summary, AYI is trading near a weakening support zone and has valuation issues, but a potential M&A catalyst could re-shed light on this stock. AYI is a stock to watch.
Thanks for the reading!