How Will the Acuity Brands Selloff Affect Your Portfolio?

Source: Thinkstock

Source: Thinkstock

Acuity Brands Inc. (NYSE:AYI) is a stock that I have traded numerous times in the last few years. The stock is getting hammered today after a disappointing earnings report, down about 10 percent right now. But in just one year the stock is up 80 percent. By playing call options on this stock, investors have made truckloads of money. But now the stock is pulling back. Should we buy the stock here, or speculate in some options? Well, to answer this question we must first understand the business and then discuss its recent performance as well as future prospects.

So, what does Acuity Brands do? Well it designs, produces, and distributes lighting solutions, components, and services for commercial, institutional, industrial, infrastructure, and residential applications. The company offers indoor lighting products, such as recessed, surface, and suspended lighting products, as well as downlighting, decorative lighting, emergency and exit lighting, track lighting, daylighting, and special-use lighting products. It also offers outdoor lighting products comprising street and roadway, underwater, parking garage, area, pedestrian, flood, decorative site, and landscape lighting products. It also provides lighting controls, such as occupancy sensors, photocontrols, relay panels, architectural dimming panels, theatrical, and integrated lighting controls systems.

In addition, the company is involved in monitoring and controlling lighting systems through network technologies, as well as commissioning control systems. Home and business owners may be familiar with how the company markets its lighting solutions under the Lithonia Lighting, Holophane, Peerless, Mark Architectural Lighting, Hydrel, American Electric Lighting, Gotham, Carandini, RELOC, Antique Street Lamps, Tersen, Winona Lighting, Synergy Lighting Controls, Sensor Switch, Lighting Control & Design, Dark to Light, ROAM, Sunoptics, Axion Controls, acculamp, Pathway Connectivity, Healthcare Lighting, and eldoLED brand names. Finally, it serves electrical distributors, retail home improvement centers, electric utilities, utility distributors, national accounts, lighting showrooms, original equipment manufacturers, energy service companies, and U.S. government and municipalities. Given that lighting will always have strong demand, this company isn’t going anywhere. But will the stock?

Well, the company’s third-quarter net sales came in at $603.9 million, an increase of $62.4 million, or 11.5 percent, compared with the year-ago period. That is excellent growth. Net income was $43.8 million, an increase of $12.1 million, or 38 percent, compared with the prior-year period. Quarterly diluted earnings per share of $1.01 increased 38 percent compared with $0.73 for the year-ago period.

Fiscal 2014 third-quarter adjusted net income of $43.3 million increased $1.4 million, or 3 percent, compared with prior year’s $41.9 million. Adjusted diluted earnings per share for the third quarter of fiscal 2014 of $1.00 increased 3 percent compared with prior-year’s adjusted diluted earnings per share of $0.97. The 11.5 percent year-over-year growth in fiscal 2014 third-quarter net sales was due primarily to a 13 percent increase in sales volume, which was partially offset by an approximate 1 percent negative impact from changes in the price and mix of products sold (price/mix) and half of a percentage point from unfavorable changes in foreign currency rates. The increase in sales volume was broad-based across most product categories and key sales channels in North America.

What is impressive is the company’s gross margins, although the street is reacting negatively since they dipped slightly. Fiscal 2014 third-quarter gross profit margin was 40.3 percent compared with prior year’s adjusted gross profit margin of 41.0 percent. In addition to unfavorable price/mix, fiscal 2014 third-quarter gross profit margin was negatively impacted by approximately 70 basis points from a combination of $2.1 million of higher warranty related costs associated with a specific non-LED product and $2.1 million of unfavorable changes in foreign currency rates. Fiscal 2014 third-quarter gross profit was also negatively impacted by approximately 20 basis points due to certain inefficiencies associated with the ramp up of the company’s electronic component production capabilities, including LED programmable drivers and light engine boards.

Backing these out, gross margin would have improved. The company plans to continue to accelerate its investment and production capabilities in electronic components for LED lighting solutions that deliver superior functionality and quality in order to capitalize on this growing market. Management expects that the inefficiencies resulting from this ramp up to continue to negatively impact gross profit margins over the next few quarters until volumes are at a sufficient level to absorb certain costs and initial production inefficiencies are mitigated. This is a huge negative and I believe this is the primary reason the stock is selling off.

Certainly, it is not selling off for profit fears. Operating profit for the quarter was $72.6 million, an increase of $22.6 million, or 45 percent, over the year-ago period. Adjusted operating profit (excluding the impact of the fraud recovery) increased $5.7 million, or 9 percent, to $71.8 million compared with prior-year’s adjusted operating profit (excluding the impact of special charges, related temporary manufacturing inefficiencies, and fraud loss) of $66.1 million.Vernon J. Nagel, Chair, President, and Chief Executive Officer, stated:

We were pleased with our fiscal 2014 third-quarter results as we continued to execute our strategies to extend our leadership position in North America. The year-over-year increase in net sales reflects continued favorable trends in our order rates as well as the continued adoption of LED lighting solutions, which nearly doubled over the prior year. Sales of LED-based lighting solutions now represent over a third of our net sales. We believe our third-quarter results reflect our ability to provide customers truly differentiated value from our industry leading portfolio of innovative lighting solutions along with superior service. This past June, our new Peerless® Open LED luminaire was recognized as the sole recipient of the annual Most Innovative Product of the Year award from the LIGHTFAIR® International 2014 awards competition.

During the conference and trade show, we also introduced the Aera lighting system, which delivers functional white light to a space while allowing users to create, personalize, and enhance their environment through dynamic color changing windows, and we demonstrated visible light communication technology using Lumicast technology from Qualcomm Technologies, Inc., a subsidiary of Qualcomm Incorporated, that will allow retailers to engage with customers on mobile devices based on their location in the store. In addition, we recently introduced four new product families of organic LED (OLED) based luminaires making Acuity Brands one of the largest providers of OLED fixtures in the world, and we announced the launch of XPoint Wireless and xCella Wireless control systems. These are just a few examples of our growing portfolio of innovative lighting solutions.

Looking ahead, I am actually very bullish about Acuity’s prospects for future profitable growth. Third-party forecasts and leading indicators suggest that the growth rate for the North American lighting market, which includes renovation and retrofit activity, will be in the mid-to-upper single digit range during remainder of calendar 2014 with expectations that overall demand in Acuity’s end markets will continue to gradually improve over the next several years. While the stock is pulling back, I think there is opportunity to get long. I would love to see the stock dip below $120, where I would consider it a must buy given its growth rate. The company deserves to trade at a premium multiple given its growth. Take advantage of this selloff and do some buying if it dips further.

Disclosure: Christopher F. Davis currently holds no position in Acuity Brands and no plans to initiate a position in the next 72 hours, although he has traded options on the stock in the past. He has a tentative buy rating on the stock should it dip below $120, and an eventual $142 price target.

More From Wall St. Cheat Sheet: