Having covered Orion Energy Systems (OESX) since 2015, it has proved to be an unprofitable long-term investment. In spite of an extended period of underperformance, the company has survived a difficult and expensive transition to LED lighting, entailing a total reconfiguration of the company's product line and distribution system. While the vast majority of stocks trading near $1.00 represent broken businesses that should be avoided, Orion offers a viable business that is positioned well for future growth, as will be illustrated further.
Current market fundamentals
Since early in the decade, LED lighting has been predicted to undergo massive adoption through the end of the decade and beyond to replace incandescent and fluorescent legacy lighting. LED lighting offers energy savings of as much as 75-80% compared to incandescent and impressive savings when compared to fluorescent and CFLs. As documented in a government report, LED lighting adoption in the United States between now and 2027 has the potential to save energy consumption equivalent to 14 major power plants across the U.S., resulting in energy savings of about $30 billion annually.
While LED adoption has occurred, the pace of industrial and commercial adoption has not met expectations of suppliers who have made major investments in new product development for LED fixtures and other equipment. In fact, at least one manufacturer, GE, exited the commercial lighting business, selling its commercial lighting division toward the end of last year. It was ironic that GE was a large customer of Orion-supplied industrial lighting installed in plants of the industrial giant. Other LED players have struggled with deteriorating revenue and earnings in the last 24 months as stock prices languished. Accordingly, the stock chart graphic below illustrates the underperformance of six pure-play LED lighting suppliers during the last six month period.
Other than Acuity Brands (NYSE:AYI), the group represents very small players, albeit pure plays in lighting. The charts illustrate across-the-board underperformance. Both LSI Industries (NASDAQ:LYTS) and Revolution Lighting (NASDAQ:RVLT) continue to trade near the bottom in the charts. In comparison, Orion Energy Systems stock has begun a recovery that has held up well in 2019, breaking the downward trend, and is a standout in the comparison.
Another headwind for LED fixture suppliers has been the replacement of bulbs or tubes only in conversion to LED. While bulbs or tubes can be the least expensive alternative initially, the conversion does not provide optimum performance over time with fixtures that were configured for legacy lighting. Further, Orion estimates that fixtures represent only about 5% of the total cost of lighting deployed over 25 years. Beyond cost, new LED fixtures can include connected devices for network IoT deployment, making LED fixtures smart devices that offer features far beyond lighting.
While a large percentage of Acuity Brand's business is retail fixtures, all of the companies represented sell into commercial, office, industrial, and institutional markets, which is the focus of Orion's business. Previously, Orion operated exclusively in the industrial and institutional markets but has moved more broadly into commercial, office, and specialty applications with expanded product offerings.
The strength of the Orion product line and expertise in the industry offer a distinct advantage that should be rewarded as the business recovers and builds. Orion advantages have been fully illustrated in previous articles that can be linked. Further, the scope of Orion advantages is illustrated in an investor presentation recently posted by the company. In addition, Orion offers multiple control systems, networking solutions, and IoT options with a full choice of options from multiple suppliers including Enlighted, Daintree Networks, PacWave, Magnum, Lutron, Philips, Legrand, and InteLite, for a full integration of lighting systems. Accordingly, Orion can integrate just about any type of enabled devices clients may prefer. As illustrated in the graphic below, Orion now offers enabled devices in all luminaires.
(Source: 2018 Annual Shareholder Meeting Presentation)
The table below illustrates Orion revenue, expenses, and earnings over the last eight quarters. From the data presented, it can be readily determined that the reason for poor performance has been revenue related, with a 12.3% decline in revenue over eight quarters. The revenue issue has been a recurring problem seen throughout the industry, including with companies not discussed above. For example, Cree, Inc. (NASDAQ:CREE) reported a 19% decrease in lighting revenue for the last full-year results (source: Form 10-K). Although Cree is not a pure play in lighting, the segment represented 38% of its business. In spite of the revenue decline, Orion management executed well in decreasing expenses over the eight quarters with a 60.5% decrease in general and administrative and 32.2% decrease in sales and marketing expenses. At the same time, net income and EPS improved 93.9% and 94.9% respectively over eight quarters. Although still reporting a loss, management has been successful in moving toward profitability even as revenue declined markedly. Cutting expenses to meet or exceed declining revenue has given strong indication of the management's ability to effectively run the business.
Operational improvement over the eight quarters can be shown graphically in the chart below, illustrated by improved earnings metrics even as revenue declined.
Concerning gross margins, which as of the end of Q3 was 25.6%, management has consistently guided margin targets of 30%-plus, which should normalize as volume builds.
The foregoing illustrates the effectiveness of management as well as highly dedicated employees, in controlling expenses, achieving net results to near break-even status. The lean operation and expense control discipline should propel earnings once revenue begins an upward track.
Meanwhile, Orion has been reporting new business wins and has stated that the company has experienced an uptake in interest in new lighting projects. As previously discussed, the company in past years operated mostly in the industrial lighting space and branched out into commercial and office after a key acquisition and expansion of product offerings. In addition, the company previously marketed its products almost exclusively through in-house marketing and national account base. In the 2015-2017 time frame, Orion assembled a network of nationwide sales agencies to expand the addressable market of its products to cover 75% of the installed base. Recently, the company has placed a renewed focus in developing its national account base. The combined distribution strategy should position the company to maximize future growth.
With a current market cap of approximately $29.6 million and trailing revenue of $58.4 million, Orion Energy Systems offers a great deal of value at a price-to-sales ratio of .51 (Source: Finviz.com). It should also be noted that, while revenue has come in weaker than expected, management continues to offer guidance of a 5-10% increase in revenue for full-year fiscal 2019. As stated by CEO Mike Altschaefl, on a recent Q3 conference call:
… we have reiterated our full fiscal 2019 revenue growth goal of 5% to 10%. While this might seem modest compared to the solid national account momentum we have discussed, it merely reflects the anticipated timing of current project activity through March 31st of this year…. Given the results of our first three quarters, our 5% to 10% growth goal would require fourth quarter revenue between $20 million and $23 million in order to achieve the full year growth range. And though our quarterly results will continue to vary based on project timing and other factors, a Q4 performance within this range would underscore the growth we are actively working to achieve."
In any event, if the company comes in near the stated goal with a good Q4, the stock price should react favorably.
Beyond the results achieved in Q4, Orion management has proved to be effective in managing the downturn in business for an extended period of time. With low long-term debt at a ratio of .18 and current ratio of 1.5, the company appears very capable of managing the business to success, especially with improved prospects beginning in Q4.
The Orion management team and directors have been consistent buyers of the stock and, as noted in the Finviz.com link above, insiders currently own 21.5% of outstanding shares. Stock purchases by insiders during 2018 were completed mid-year 2018 in a range of market prices comparable to where the stock is currently trading. No sales have been reported by insiders other than by a former CEO who left the company in 2017.
As a very small company with limited financial resources and no history of profitable operations in recent years, Orion Energy Systems should be considered a speculative investment that may not be suitable to many investors. While the author believes Orion will prove to be profitable for some investors, small stocks like Orion can be extremely volatile, causing short-term investors to sell at a loss. Readers should not invest in the company based solely on the content of this article, and do so only after full consideration of risks outlined in Form 10-K beginning on page 11.
Small company stocks that disappoint can be profitable investments for long-term investors who have the patience to wait out short-term pain as business languishes, which necessitates continual reassessment of fundamentals. When fortunes change, they can explode to the upside.
After analyzing data from industry participants, it became apparent that revenue was an industry-wide problem. Orion has managed its way through a formidable business environment in LED lighting, bringing the company to near-break even status. Accordingly, the company should be positioned well for better times ahead. Good luck to Orion investors.
Disclosure: I am/we are long OESX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.