Description

INVESTMENT THESIS      

LSI Industries, Inc. (“LYTS” or the “Company”) under a newer management team has focused the business on higher value and more specialized products, culled less productive lines, restructured its sales network, rationalized facilities and operations and sold-off non-core assets. These operating and financial initiatives over the last year and a half have resulted in a more attractive business profile--higher margins, longer-term contracts, higher returns, reduced leverage, etc. This coupled with recent business wins and a favorable secular impact from Covid-19 will lead to a reacceleration in revenue over the coming quarters. Lack of institutional following, limited corporate communication and an underappreciation of LYTS’s improved profile have resulted in a significant price-value disconnect. We believe the stock has +50% near-term upside and is a double from its current price over the next four quarters.       

CATALYSTS         

Near and medium-term catalysts to value realization include: 1) financial performance from new contracts and higher margin revenue mix; 2) increased appreciation for the quality of the business; 3) additional asset sales; 4) improved corporate communication; and 5) potential sale.

In mid-April, LYTS won a +$100M contract from a QSR to install new digital menu boards across its 6,000 locations. This alone will add $9M of revenue per quarter, equating to a 10-12% annual increase in revenue over the next 4-5 years. Over the last year and a half, LYTS has purposefully exited some of its lower margin product categories. This led to a temporary decline in the top line but the majority of that undertaking is now complete. Following the recent program wins, the Company is about to transition from a revenue decliner to a grower. This will lead to increased earnings, improved optics and share re-rating. Further, LYTS hired a new head of commercial sales in Q1. Indications are he is already making significant contributions.

The Company has historically had limited investor outreach but the new management has indicated that with much of the operating improvements behind them, they will likely be pursuing sell-side coverage and increasing corporate communication by attending investor conferences (scheduled to present at the Canaccord and Sidotti conference over the coming months).

BUSINESS OVERVIEW & REVENUE DRIVERS

LYTS provides digital and conventional signage and lighting to commercial and retail customers in the US and to a lesser extent, Mexico. Indicative customers include QSRs (Wendy’s, Burger King, Starbucks), retail/ grocery (CVS, Stop & Shop), C-Stores/ retail petroleum (7-Eleven, Exxon Mobil, Chevron, Shell), auto dealerships (Nissan, Honda, CarMax) and larger municipalities and institutions. The Company’s projects range from individual location replacements to national overhauls across a customer’s franchise base. The latter make up the majority of its revenue, typically last 4-5 years per project and involve replacement of illuminated external signs, displays and internal digital signage, displays and lighting. Multi-unit operators want to maintain a consistent brand image, appearance and lighting environment across their units. LYTS is able to out-compete its smaller peers due to its national presence and breadth of services (i.e. it can offer integrated solutions across all display types).

Approximately 30% of the Company’s revenue comes from the petroleum vertical. We estimate that LYTS has a 60-70% market share in this segment in the US. It currently has six large multi-year programs underway with retail gas station chains. While petroleum is a mature industry in the US, drivers of growth in the category for LYTS include upgrades to more energy efficient lighting, merger-related rebranding and refurbishment and store upgrades. Gas stations barely make any money at the pump; all profits are derived from concessions so maintaining an appealing in-store is critical. Thus, there is a renewal and upgrade cycle every 6-7 years for most brands. One of the Company’s larger customers, Valero, is making an aggressive push into the Mexico market. This is in its early stages and should serve as an increasing source of future business for LYTS.

The Company’s market share in the other categories is lower but the same competitive advantages it possesses in petroleum should enable it to out-compete and capture a larger share in those verticals. According to a QSR executive, “as an end-user of digital signage, we look for someone to partner with, not just supply us with a product. We sought a vendor who would strategize on the best spots to deploy our digital signage for maximum effectiveness. We chose LSI between other suppliers after speaking with some of their previous customers.” The best example of this is within QSR where LYTS’s recent larger contract win with a top 10 US chain (likely Wendy’s) can be seen as a validation of management’s efforts. The opportunity set here for LYTS is substantial. In order to maintain and keep up, restaurants have to routinely upgrade and overhaul their lighting, signage and menu boards. This typically occurs every 5-6 years.  

As it relates to Covid-19, LYTS has limited exposure to traditional full-service restaurants and on its last earnings call noted it had not experienced any project cancellations due to the virus. Some preliminary indications suggest that the Company may well prove to be a net beneficiary of the current environment. The primary contributing factors being an increased need for drive-in and curbside pick-up and associated signage and digital menu boards. One example of this within the Company’s existing customer base is Stop & Shop (parent: Ahold Delhaize) which is expanding its curbside pickup service to include illuminated parking spot designations with itemized displays that allow customers to modify their online order. Many other grocers and brick-and-mortar retailers are also expanding their buy online pickup in-store (“BOPIS”) offerings with several already noting PP&E investments in these areas.  

BUSINESS BACKGROUND & OPERATIONS

The Company’s prior management teams were focused on topline growth and volume with less emphasis on margins. Then, in late 2018 a new CEO, Jim Clark, came onboard and in short succession undertook a number of operational and financial initiatives. These included: 1) exiting lower quality categories and customers (primarily traditional print) and focusing on higher value added products; 2) the adoption of lean manufacturing and other operating expense reduction programs; 3) a rationalization of its production footprint and right-sizing of capacity; 4) improved purchasing discipline and working capital management; 5) an upgrade of the management team; and 6) overhead reduction. He concurrently consolidated and sold-off several facilities, the most recent of which occurred last quarter and generated proceeds of $8M. The Company has moved these operations to a much more efficient location nearby. The new lease expense is lower than the prior facility overhead and thus no incremental operating expenses will be incurred.

FINANCIAL PROFILE

The mix shift to more specialized products led to a decline in sales but along with the other initiatives, resulted in a material improvement in margins, returns and an overall more attractive business profile. Concurrently, the Company’s asset sales and increased FCF have been used to reduce its legacy debt load. The table below illustrates the changes. 

Revenue: Several key new lighting products, targeting the petroleum, convenience store, warehousing and parking garage vertical markets were launched last year. These combined with the aforementioned larger longer-term contracts position the Company to reaccelerate revenue growth.

Margins: Higher revenue on top of a more attractive margin profile will translate into higher FCF and increased earnings. While some additional undertakings are still underway, the majority of the heavy lifting is now complete. In the last earnings presentation, management noted they have identified an additional $4M in annual cost savings that they believe they can extract from the business in the near-term. This bullet point was not in the press release and was not discussed on the call so likely has gone underappreciated by the market. This implies a 5.5% EBITDA margin on the current revenue base. The Company qualified for CARES Act relief and will not be a cash tax payor in the next couple quarters.

VALUATION 

On a fully-taxed basis we believe LYTS will generate $0.60-$0.70 of cash EPS over the next twelve months. This equates to an approximately 10-11x cash EPS or an 9-10% levered FCF yield based on the current share price. The public comp set is limited with the closest peer in terms of products and end-market being Acuity Brands (AYI). AYI currently trades at a mid-teens forward earnings multiple, granted it is larger and more diversified than LYTS. The broader commercial construction services and equipment sector trades in the mid-to-high teens. Regardless of peer valuations, LYTS’s current trading multiple is way too low given its market position and trajectory. At a more appropriate 14-16x EPS multiple, the stock would trade at $10-12 per share or 50-75% above the current price. This assumes no further monetization of its facilities. 

As the discussed catalysts unfold over the coming quarters, LYTS’s multiple and stock price should increase commensurately. There is a relatively large potential set of logical strategic acquirors ranging commercial lighting OEMs like Acuity Brands (AYI) to engineering services and construction companies like AECOM (ACM), Fluor (FLR), Tetra Tech (TTEK) or roll-up NV5 (NVEE) or even distributors such as HD Supply (HDS).

OTHER INVESTMENT CONSIDERATIONS & RISKS  

• Management: Incentives are tied to FCF and ROIC with 60% of compensation in stock. CEO Jim Clark was previously the President of Alliance Tires Americas (subsidiary of Yokohama Rubber Company). Primary accounts, although limited, indicate he was an effective operator in that prior role. Before ATG, Clark was a partner at PE firm Dunes Point Capital and held management positions at GE and United Technologies. He relocated from the Northeast to Cincinnati to assume his role at LYTS. Given his M&A and investing background it seems more likely than not his objective is to improve the business and exit. Since taking the helm he has also upgraded his head of ops and sales, among several management level changes.

• Additional Asset Monetization: The Company still own 7 facilities after the sale of its Canton, OH location. Given existing capacity, LYTS could sell more locations or sale leaseback any of them.

• Retail Petroleum Exposure: A more prolonged period of fewer miles driven in the wake of the pandemic could result in retail gas operators deferring capital spending. This is in part mitigated by the fact that social distancing has compelled people to avoid public transportation in place of personal car travel. 

Catalyst

1) Financial performance from new contracts and higher margin revenue mix

2) Increased appreciation for the quality of the business

3) Additional asset sales

4) Improved corporate communication

5) Potential sale