August 24, 2016

Management’s Concerns Contradict The Market’s High Hopes For Acuity Brands


Summary

  • Acuity Brands (AYI) is expected to see record Adjusted ROA, but management’s concerns about the sustainability of sales and EPS growth implies that this may be unwarranted.
  • AYI is trading at a 27.4x V/E’, which is near historical highs.
  • At these levels, the market is pricing in expectations for an increasing Adjusted ROA, from 27.2% in 2015 to 59.77% in 2020, accompanied by 2.8% Adjusted Asset growth.
  • Management’s concerns about the sustainability of sales and EPS growth, as well as increasing SDA expenses, indicate that market expectations for record ROA’ may be too bullish.
  • As a result, multiple compression and equity downside may be warranted.

AYI PVP

AYI has historically seen improving ROA’, ranging from 10%-12% levels in 2001-2006, before increasing to 20.4% in 2008, and declining to 15.4% in 2010. Since then, ROA’ has increased steadily, reaching 27.2% in 2015. Meanwhile, Asset’ growth has been volatile, positive in eleven of the past fifteen years, and ranging from -16% to 15%.

Performance Drivers – Sales, Margins, and Turns

It can be helpful to break down ROA’ into its DuPont formula parts, Earnings’ Margin and Asset’ Turns, which are the cleaned up margins and turns metrics used to calculate ROA’. The chart below details both Earnings’ Margin and Asset’ Turns historically, to help us better understand the drivers of the firm’s profitability and performance.

AYI SMT

Valuation Matrix – ROA’ and Asset’ Growth as Drivers of Valuation

When valuing a company, it is important to consider more than a singular target price, and instead the potential value of a firm at various levels of performance. The below matrix highlights potential overvalued or undervalued prices for AYI at various levels of profitability (in terms of ROA’) and growth (Asset’ growth.) Prices that are in excess of 10% equity upside are highlighted in black, and prices representing an excess of 10% equity downside are highlighted in red.

AYI VM


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