North America's leading lighting company, Acuity Brands (NYSE:AYI), released its quarterly results recently, cheering the market with its positive outlook. The company offers good long-term growth prospects from both the increase in demand for LED lighting and a recovery in commercial and industrial construction. The market seems to have fully woken up to this story, however, and the company needs to deliver in order to justify the current evaluation. Is now the time to be chasing the stock?
An LED play
The growing acceptance of LED lighting is good for Acuity for two main reasons. First, it is seeing replacement demand coming from customers wanting to use LED lighting. Second, this type of lighting usually comes with control systems, so Acuity can generate add-on sales for the systems. Moreover, these demand sources don't rely on the economy or overall construction activity. In reality, it's more of an opportunity to grow sales (rather than margins), because its LED lighting solutions tend to have similar margins to conventional lighting.
Unfortunately, management didn't disclose the exact share of revenues coming from LEDs, but they outlined that it was at least above 21%. Consider that the last three quarters' numbers have been 13%, 15%, and 20%, respectively, which represents very good growth.
More than an LED play
Acuity also offers earnings upside from an improving economy, and this time there are margin growth opportunities as well. Construction activity appears to be picking up, as seen in the Architectural Billings Index from the American Institute of Architects:
The hope is that growing residential activity will ultimately translate into commercial and industrial construction. Increased housing construction implies the build-out of commercial buildings around the new communities. In addition, a resurgent housing market tends to grow household net worth, which in turn leads to increased consumer spending. Ultimately, this feeds into commercial and industrial construction investments in line with an improving economy.
All of this positively affects Acuity in two ways. First, its strongest market has traditionally been the commercial and industrial sector, and any increase in activity will aid its top line. Second, new construction work is likely to create a higher margin mix than Acuity has now. For the second quarter in a row, Acuity saw its volumes rise 14%, though net sales increased by only 11% last quarter and 13% this time around. On the conference call, Acuity explained the discrepancy as being primarily due to changes in the channel mix, as well as the mix of products sold, and, to a lesser degree, lower pricing on like-kind LED luminaires.
Acuity's renovation work tends to be lower-margin activity, as does its sales through the home improvement stores like Home Depot and Lowe's. Clearly Acuity has a margin expansion opportunity provided that the new construction market improves next year.
Wal-Mart lights up the way
One catalyst for growth could come from Wal-Mart (NYSE:WMT), as it recently launched an LED light bulb selling for under $10. Analysts are mixed over the potential outcomes, with some seeing future margin pressure to come for Home Depot's LED bulbs (an important retailer for Acuity), and downward pressure on Cree's LED lighting margins.
On the other hand, Wal-Mart's move is highly likely to spark wide-scale interest in LED lighting. This could turn out to be a net positive for the industry. Cree is also a large scale LED manufacturer, and an increase in end demand should help it to lower its prices. Meanwhile, Cree and Acuity could find it easier to convince customers to buy their lighting solutions if Wal-Mart's move creates mass awareness of the benefits of LEDs.
The bottom line
There is a lot to like about Acuity, but at a price of $92.80 per share as I write, the company's stock is at 23 times its earnings forecast to August 2014, and around 20 times to August 2015. It looks priced for perfection, and any hiccup with short-term pricing due to Wal-Mart's move will hurt the stock. If you think the commercial construction market is going come back strongly next year, Acuity Brands stands to reap the benefits, but there are probably cheaper ways to play the idea.
Lee Samaha owns shares of Home Depot. The Motley Fool recommends Home Depot. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.