Acuity Brands (AYI) Rides on Product Innovation, Costs High

Innovative lighting control solutions and energy-efficient luminaries, cost-saving initiatives, and strategic acquisitions are substantial growth drivers for Acuity Brands, Inc. AYI. Recently, the company reported second-quarter fiscal 2019 results, wherein adjusted earnings surpassed the Zacks Consensus Estimate by 11.2%. In fact, it surpassed analysts’ expectation in each of the trailing four quarters.

However, higher material and freight costs, along with softness in the lightening industry are pressing concerns for Acuity Brands.

Notably, shares of Acuity Brands, which has outperformed its industry over a year. The stock has gained 7.3% against its industry’s fall of 1% in the said time frame.

Let’s delve deeper into the factors that substantiate its Zacks Rank #3 (Hold).

Key Growth Drivers

Product Innovation: Acuity Brands continues to expand its portfolio of innovative lighting control solutions and energy-efficient luminaries to drive top-line growth. Moreover, the company continues to introduce new products and capitalize on market opportunities. In fiscal 2018, it introduced almost 100 new product families to its industry-leading portfolio, in turn gaining market share in product categories and sales channels. Its Atrius-based IoT luminaires and solutions in the retail segment are becoming the industry standard. The company remains focused on expanding these solutions in other channels.

Notably, in first-half fiscal 2019, net sales grew 6.7%, driven by a 7% increase in volume and 1% favorable impact from acquisitions (net of divestitures). The company witnessed greater shipments across most channels and geographies.

Cost-Saving Initiatives: Acuity Brands has undertaken several initiatives that are expected to offset higher input cost and the negative impact of tariffs. These actions include price increases and other cost-reduction strategies. The company has been increasing prices in order to offset the negative impact of higher material cost, which mainly stemmed from inflationary effects and tariffs by the government on Chinese finished goods and components.

Adjusted selling, distribution and administrative or SD&A expenses, as a percentage of net sales, contracted 150 basis points (bps) in the fiscal second quarter. The improvement was backed by reduced freight and commission expense, and productivity improvements. Adjusted operating margin increased 50 bps year over year during the quarter. The trend is expected to continue in the upcoming quarters as well driving margins in a positive direction.

Expansion Via Acquisitions: Acuity Brands focuses on expanding its geographic borders and product portfolio through strategic acquisitions and joint ventures. Notably, acquisitions, net of divestitures, added 1% to its total revenues in first-half fiscal 2019. The company spent $164 million for the acquisition of IOTA Engineering and Lucid Design Group in fiscal 2018.

Being an industry leader in emergency lighting and power equipment for commercial and institutional applications, IOTA will enhance its market leadership in this important lighting category. Lucid provides a data and analytic platform to facilitate data-driven decisions, in a bid to improve building efficiency, and drive energy conservation and savings.

Concerns

Rising Material & Freight Costs: Energy-efficient luminaries and innovative lighting control solutions require regular research and development, and hence involve costs. Again, commodity costs, especially steel prices, are increasing owing to the recently enacted tariffs. In first-half fiscal 2019, the company’s adjusted gross margin declined nearly 150 bps, owing to the above-mentioned headwinds. The downside was primarily due to higher input cost in electronic and certain oil-based components, along with freight and commodity-related items, particularly steel prices. Adjusted operating margin contracted 60 bps during the same period.

The company remains cautious about labor shortages in the construction industry and uncertainty related to both infrastructure spending and federal regulatory and trade policies in the upcoming quarters.

Soft Demand in the Lighting Industry: Current market conditions in the lighting industry continue to create a challenging environment for Acuity Brands and similar companies. Although the company’s overall growth rate increased in low-single digits on a sequential basis, it still remains cautiously optimistic for fiscal 2019 results. The company believes that the overall growth rate of the construction market will decline due to continued product substitutions to lower-priced alternatives and labor shortages in some markets.

Stocks to Consider

Some better-ranked stocks in the Zacks Construction sector are KBR, Inc. KBR, Armstrong World Industries, Inc. AWI and EMCOR Group, Inc. EME, each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

KBR, Armstrong World and EMCOR’s earnings for the current year are expected to increase 8.5%, 21.9% and 6.9%, respectively.

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