Acuity Brands: Rolling Downhill

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About: Acuity Brands, Inc. (AYI)
by: ThreeThree Capital Research
Summary

Acuity has lost half its price over the last few years.

The stock still seems to be overvalued.

Uncertainties about growth potential and legal proceedings are problematic for Acuity.

Acuity Brands, Inc. (AYI) is a holding company, which owns companies operating in the lighting industry. Its brands are considered to be some of the best in the industry. The company is based in Atlanta and employs over 13,000 people.

Acuity designs and produces everything from lighting controls and building system controllers to power supplies and integrated systems for industrial purposes. Acuity was trading at over twice its current price towards the end of 2016. As such, value hunters have been eagerly watching Acuity so as to determine whether it is a worthwhile investment at its current price.

While Acuity looks like a decent company from a non-technical standpoint, our valuation metrics show otherwise. As such, we are delving deep into Acuity to determine whether this is a place where your hard-earned cash should go or not.

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Acuity is poised to take advantage of the IoT industry

The Internet of Things (IoT), along with cloud computing, seems to be the next big thing in technology. IoT essentially refers to the concept of connecting everything in your life to the internet to achieve complete control of everything you do. For example, you could turn your lights on or off from your mobile phone while on vacation.

The total number of IoT devices is expected to be over 20 Billion by the end of 2020. On top of that, the estimated investment to be made by companies in IoT is $15 trillion between 2017 and 2025. Acuity has two brands that are currently operating in the IoT space and could garner a significant portion of the industry.

Atrius is a brand that is focused on using lighting grids as sensors and collecting data for various companies, while DGLogik is focused on the development side of IoT as it provides software solutions for developers to program their IoT devices to their liking. As IoT becomes an integral part of our life, Acuity could potentially profit greatly from its current brands.

Legal troubles threaten Acuity

Any mid-cap company, such as Acuity, is bound to have a few lawsuits filed against it. However, Acuity seems to have attracted significant trouble as far as the legal side of things is concerned. A brief look at its 10-K reveals that it has legal proceedings “including, but not limited to, patent infringement, product liability claims, and employment matters.”

On top of this, the company is involved in multiple securities class action suits filed by investors who lost money during the stock’s massive crash towards the tail-end of 2016. The company is either partially, or completely, insured against some of the claims that have been made and claims that most of the legal proceedings against it should have no impact on their cash flow or financial condition even if the outcome is adverse. However, it remains to be seen whether that is actually the case or not.

Two of the lawsuits filed against the company state that directors mislead investors by overstating the company’s ability to generate profits. If that is the case, Acuity is a company that investors looking for a safe investment should definitely avoid. It is quite difficult to predict the outcome of these lawsuits. Because of this, the lawsuits currently cast a shadow of uncertainty over the company.

Valuation

In terms of growth, Acuity Brands is currently struggling. Although a brief look at the company’s revenues and net income may lead you to believe that there is ample growth in the company, the actual operating profit fell in 2018, after a minor growth in 2017, and the increase in net income has been mainly artificial due to tax breaks.

Along with the increase in revenues came an increase in operating expenses. Not only did the cost of sales go up by a proportional amount, but so did the administrative and general expenses. This shows that Acuity is failing to achieve economies of scale and this could lead to growth and scaling problems down the road.

Acuity also falls short when it comes to our DCF analysis. Even when we assume a 5% growth for the next 5 years, a 2.5% growth for the 5 years thereafter, a terminal value multiple of 16.8 (its current TV multiple), and a discount rate of 10%, the intrinsic value of the stock is $127.09 a share. The price of Acuity's stock at the time of our analysis is $132.90, making this a slightly overvalued stock.

The problem is that these growth rates are fairly optimistic considering Acuity’s current growth problem. If we perform a conservative analysis which factors in only a 2% annual growth for the next decade, we find the stock’s intrinsic value to be $113.29 - making it quite a bit overvalued at its current price.

The balance sheet also paints a dire picture for Acuity. Not only are its receivables increasing massively every year, but its inventories are also rising. This shows a decrease in operational efficiency. In addition, its current assets have decreased to $1.21 billion in 2018 from $1.41 billion in 2015, while its current liabilities have increased from $520.90 million to $682.70 million over the same period.

Risks

Acuity Brands is currently stagnant. Despite their increase in revenue, it has failed to show any substantial gains in profits. If it fails to capitalize on the IoT trend (the advent of which is in itself not a guarantee and thus, is a risk), it could face large problems in the near future.

On top of this, the multiple lawsuits that threaten Acuity could cause them significant losses. The lawsuits, of which we are especially worried about, are the ones relating to securities fraud. More information on the lawsuit can be found on the KTMC website, which is one of the firms currently in a legal battle with Acuity.

Bottom Line

Acuity seems to have better prospects for its future. On top of that, the fact that the stock price is half of what it was over two years ago seems to suggest that it might be a worthwhile investment based on value. However, our valuation of some of its fundamental factors suggests that the company is overvalued at this time.

Even if you factor in a reasonable amount of growth over the next decade, the company still seems to be slightly overvalued. As such, we recommend only investors looking for a high-risk high-reward opportunity consider Acuity or those looking to add a small position to capitalize on the trend towards IoT.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Additional disclosure: Author's note: Although we do significant research and due diligence, we are not always right with our predictions or recommendations. This also applies to our grammar; please excuse any typos you may find. This article is free to readers with the purpose of assisting with research, while also providing a forum for second-level thinking and discussion. This article is for educational purposes only; we have not considered your specific situation and we are not your investment fiduciary.