Orion: Could Sell Equity Soon

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About: Orion Energy Systems, Inc (OESX), Includes: AMRC
by: Villamayor Capital
Summary

Orion designs and sells wireless Internet of Things systems and LED lighting as well as offers energy project management in North America.

After more than 23 years of operation, the company’s most valuable asset is the know-how accumulated. As of March 31, 2019, Orion owns 104 United States patents.

The company’s system can be installed in one to two minutes, which reduces maintenance costs.

Value investors won't be impressed that Orion delivers negative FCF. It was equal to -$5.4 million in 2019, -$4.9 million in 2018, and -$2.5 million in 2017.

Orion appears to have more than $14 million in short-term financial obligations, but does not have cash in hand to make such payments.

With an innovative business model and better than expected results, Orion Energy Systems, Inc (OESX) recently saw its share price increased by 25%. The company’s P/B value per share stands at 4.5x, which is expensive as compared to other competitors. Orion reports negative FCF and negative EBITDA. This seems like a lofty valuation, and the company may need to sell equity soon, which could prompt a share price decline. With this in mind, it seems to represent a selling opportunity.

Business

Founded in 1996, Orion designs and sells wireless Internet of Things systems and LED lighting as well as offers energy project management in North America.

After more than 23 years of operation, the company’s most valuable asset is the know-how accumulated. Clients contact the company to develop energy-efficient commercial lighting systems as Orion has a consolidated position in its industry. Notice that as of March 31, 2019, Orion owns 104 United States patents:

Source: 10-k

As shown in the image below, companies like General Electric (GE), Amazon (AMZN) and Coca Cola (KO) trust the systems developed by Orion:

Source: LD Micro Invitational Conference

Among the products sold by Orion, the company appears to be successfully selling the LED troffer door retrofit ("LDRTM"), which is way better than the existing 4 feet by 2 feet & 2 feet by 2 feet fluorescent troffers. Note that the company’s system can be installed in one to two minutes, which reduces maintenance costs.

Besides, the company’s interior LED high bay fixtures offer clients a lower cost of ownership and more light with less energy consumption. Also, Orion’s interior lighting products are lightweight, which reduces installation expenses.

The images below were taken from the company’s website. They offer further details on the products sold by Orion:

Source: Company’s Website

Source: Company’s Website

Surprising Revenue, But Negative FCF

Orion recently surprised the market by delivering quarterly revenue of $22.4 million, $3.21 million more than what the market expected. The market reaction was impressive. As shown in the chart below, after the results were reported, the shares jumped by more than 25%, from $2 to $2.5:

Source: Seeking Alpha

Source: Seeking Alpha

Overall, 2019 has been quite good to Orion shareholders. The stock increased from $1 in April after the company reported a $35 million LED lighting installation contract.

Let’s take a look at the annual results, which were delivered in June 2019. For the fiscal year ended March 31, 2019, total revenue approximated to $65 million, 8% more than that in 2018. With that, the gross margin decreased from 24.3% in 2018 to 22.1% in 2019. Orion explained that the gross margin declined due to the company’s product mix on higher sales to one sizeable national account customer.

The most favorable feature is that Orion reported fewer losses from operations in fiscal year 2019. Losses from operations approximated to -$6.15 million, 52% less than that in 2018. General and administrative expenses, sales and marketing and R&D expenses were lower than those in 2018. The company has explained its efforts with the following words in the 10-K:

“The decrease year over year was primarily due to reduced employee costs due to the impact of our prior year cost reduction plan, and lower travel and entertainment and marketing expenses.” - Source: 10-k

Read more on the top of the P&L in the table below:

Source: 10-K

Value investors will most likely not appreciate that Orion delivers negative FCF, which was -$5.4 million in 2019, -$4.9 million in 2018, and -$2.5 million in 2017. The calculation of the free cash flow is given in the chart below:

Source: 10-K

Investors will most likely expect focused efforts from management in the future. It's worth noting that the company created an incentive program, under which executives will receive a bonus if EBITDA becomes positive. Read the lines below for more on the matter:

“Orion’s compensation committee approved an Executive Fiscal Year 2018 Annual Cash Incentive Program. The program provided for bonuses to be paid out on the basis of achieving positive EBITDA in fiscal 2018. Based upon the results for the year ended March 31, 2018, Orion did not accrue any expense related to this plan.” Source: 10-K

As shown in the chart below, the incentive program seems to be working well. Notice that trailing 12 months EBITDA increased in 2018 as compared to that of 2017 and 2016. If the favorable trend continues in 2019 and 2020, the EBITDA could soon be profitable.

Source: Ycharts

Balance Sheet: New Revolving Credit Facility

Cash reported at year-end (March 31, 2019) was $8.7 million, slightly lower than that in 2018. However, very recently, the financial situation deteriorated, with the company's asset/liability ratio declining from 2x to 1.47x. Orion had to obtain a revolving credit facility, which may be concerning to investors. As shown in the lines below, Orion pays an interest rate of more than 5%. As of March 31, 2019, it was equal to 6%.

“Borrowings under the New Credit Agreement generally bear interest at floating rates based upon the prime rate (but not be less than 5.00% per year) plus an applicable margin determined by reference to Orion’s quick ratio. As of March 31, 2019, the interest rate was 6.0%.” Source: 10-K

See the tables below for more information on the balance sheet. Notice that the company had almost no financial debt in 2018:

Source: 10-K

Source: 10-K

Contractual Obligations: Orion May Have To Pay $14 million In Less Than 1 Year

The table of contractual obligations is worrying. As shown in the image below, the company looks to have $14 million in financial obligations due less than one year:

Source: 10-K

As of today, Orion does not have $14 million in cash. In my opinion, the company may have to sell shares or obtain additional debt financing. If the management decides to sell shares, the share price will most likely decline.

Since 2015, the company has sold a significant amount of shares., and investors might be best to expect the company to sell more equity soon. Interestingly, very recently, the number of institutional investors declined. Readers will definitely wonder why they are selling shares. The chart below offers further information on the matter:

Source: Ycharts - Institutional Investors

Competitors And Valuation

According to the last annual report, Orion competes with the following companies:

- Acuity Brands, Inc. (AYI), Carmanah Technology Corporation (OTC:CMHXD), Energy Focus, Inc. (EFOI), Eaton Corporation plc (ETN), Cree, Inc. (CREE), LSI Industries, Inc. (LYTS), Revolution Lighting Technologies Inc. (RVLT), TCP International Holdings, Inc. (OTCPK:TCPIF), Hubbell Incorporated (HUBB), Ameresco, Inc. (AMRC), Johnson Controls, Inc. (JCI) and Honeywell International (HON)

Some of these competitors are very large, and perhaps not good comparisons for Orion. For instance, HON with revenue of $40 billion and JCI with revenue of $27 billion.

Source: Ycharts

Source: Ycharts

Orion does not report positive EBITDA, which is concerning.

As shown in the chart below, the EV/Forward Revenue ratio of competitors is equal to 0.01x-4.1x:

Source: Ycharts

As of March 31, 2019, Orion’s weighted-average shares outstanding are equal to 29.43 million. With shares at $2.78, the market capitalization approximates to $81 million. With cash of $8.7 million and financial debt of $9.2 million, the enterprise value is equal to $81.5 million.

Investors should notice that the company expects to reach $135 million to $145 million in FY 2020, 100% to 120% more than that in FY 2019. It appears quite optimistic. Notice that Orion’s Q4'19 revenue increased by 49% amounting to $22.4 million as compared to $15.1 million in Q4'18 due to a contract from a national account customer. In the 8-K, Orion notes that $135 million is not implied guidance, but a financial objective. Read more on the matter in the lines below:

Source: 8-K

For the fiscal year ended March 31, 2019, revenue was equal to $65 million. With the new $35 million LED lighting installation contract, let’s assume forward revenue of $90 million. With these figures in mind, the company trades at about 0.90x forward sales.

On a P/B basis, Orion also looks overvalued. The company trades at more than 4.5x its book value per share. Other competitors are selling at 0.07x to 3x. Also the company’s liabilities/assets ratio is higher than that of competitors. Orion seems to have more operating risk than its peers.

Source: Ycharts

Notice that a large stock owner sold 3.99% stake very recently at $2.45 to $2.91. Smart money managers seem to believe that Orion is trading at an expensive valuation.

Source: SEC

Conclusion

The recent results were very favorable. However, the market appears to have overreacted to the upside.

Orion has recently delivered favorable results, which surprised the market. With that, I believe that investors have overreacted. The company is now trading at 4.5x its book value per share while other peers are selling at 0.07x to 3x. Without positive FCF and positive EBITDA, investors cannot justify such a high valuation.

Additionally, Orion may need to pay more than $14 million in financial obligations in less than one year. The company does not have cash in hand to make such payment, and is cashflow negative. With this in mind, I believe the company will most likely try to issue more equity soon, which should lead to share price depreciation. To sum up, Orion looks like a selling opportunity.

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.