There is a compelling opportunity to buy the stock of a lighting manufacturer that is well positioned to benefit as a transition from conventional lighting products to solid state light emitting diode (LED) technology takes place. The company is LSI Industries (LYTS), and it is focused on producing lighting and graphics display products for chains of gas stations, convenience stores, and other multi-site retailers including quick service and casual restaurants, retail chain stores, and car dealerships.
Increasingly retailers are choosing LED lighting and graphics display products for new construction and retrofits, because it makes good financial sense based on LED's energy efficiency, long life, durability, and low maintenance compared with conventional lighting and graphic display products. Currently about 27% of LSI's total sales are LED products. This percentage is likely to increase substantially, and the transition to LED products should drive sales and earnings significantly higher at LSI in coming years.
LSI is based in Cincinnati, Ohio, and almost all of its sales take place in the U.S. Representative customers include BP (BP), Chevron (CVX), Texaco, 7-Eleven, ExxonMobil (XOM), Shell (RDS-A), Burger King (BKW), Dairy Queen, Taco Bell, Wendy's (WEN), Best Buy (BBY), CVS Caremark (CVS), JC Penney (JCP), Target (TGT), Wal-Mart (WMT), Chrysler, Ford (F), General Motors (GM), Nissan, and Toyota.
The following table shows sales, adjusted EPS, and adjusted EBITDA for LSI in recent years in millions of dollars except the per share amounts. Adjusted earnings exclude unusual items with the most significant items being non-cash goodwill and intangible asset impairment charges.
YE June 30
LSI has been hurt over the last four years as new construction of retail stores slowed and companies deferred capital spending on lighting and graphic displays. However, this slowdown and the deferrals will likely be caught up in the next several years.
A look at another company's attempt to profit from the transition to LED is helpful in anticipating what can go wrong and why LSI can be successful. The company is Lighting Science Group Corporation (LSCG). It is a public company, but a private equity firm, Pegasus Capital, owns 83.4% of the common stock, and all of what it manufactures and sells are LED products.
Lighting Science has dramatically increased sales to $109.0 million in 2011. However, the company has sustained operating losses since its inception, and they have not generated positive cash flow for any reporting period. In fact, profitability has been so bad that cost of goods sold has exceeded sales by a relatively large amount for the last two years, and after operating expenses, losses have been huge.
What this illustrates, I believe, is the problem of manufacturing and selling nothing but LED products relatively early in a technology transition. This problem is exacerbated by the fact that much of Lighting Science's product mix is LED bulbs designed to replace incandescent and compact fluorescent bulbs in homes, and this is probably one of the last uses of LED technology that will gain widespread acceptance.
Contrast this with the fact that about 27% of LSI's sales come from LED products. LSI has the growth prospects associated with LED, but they also have conventional lighting and graphics display products as a base to support the LED growth. Furthermore, the LED products that LSI offers are probably very close to widespread acceptance by retailers.
It is also noteworthy that sales activity and profitability can be quite lumpy at LSI. An example of this is the fact that LSI was awarded a supply contract to retrofit LED lighting at over 1,100 7-Eleven gas stations, and this was subsequently expanded to include the conversion to LED lighting at approximately 2,800 of 7-Eleven's convenience store sites. Consequently, sales to 7-Eleven were $42.0 million and $40.0 million for the years ended June 30, 2010 and June 30, 2011 respectively. I think it is quite likely that LSI will be successful in being awarded similar or even larger LED supply contracts with other retailers in the coming years.
The prospect of LSI being awarded new relatively large LED supply contracts is what I find most compelling about the company as an investment. The following example, although it is hypothetical, illustrates the potential.
Kroger (KR), the large food retailer, prides itself on the achievement of energy efficiency. The company cites its use of LED lighting in achieving energy savings. However, thus far this use of LED has primarily been confined to lighting in glass door frozen cases, fresh meat cases, and back room coolers and freezers. There are still large energy and cost savings that could be derived from further conversion to LED. This could encompass use in overhead lighting in stores, outdoor and parking lot lighting, and canopy lighting in company owned gas stations.
All it would take is for LSI to get the supply contract for Kroger's conversion to LED canopy lighting in its gas stations or for overhead lighting in one of Kroger's large banners like Fred Meyer to have a significantly positive effect on sales and earnings. This is just one example of the many retailers that will almost inevitably be making these kinds of lighting conversions in the coming years, and LSI is well positioned to serve many different retailers as they make the transition to LED.
LSI has a strong balance sheet with no debt and surplus cash. This balance sheet coupled with relatively good cash generating power could make the company a good candidate for an LBO.
At $6.61 per share and based on trailing earnings, the valuation of LSI seems rich with a P/E ratio and an enterprise value to EBITDA multiple of 47.2 and 10.1 respectively. However, I will be very surprised, if the company doesn't land some large supply contracts over the next couple of years that significantly boost sales and earnings and make the current stock price look cheap.
Disclosure: I am long LYTS.