Inaugural Acuity Brands deal prices well behind peer
admin | October 30, 2020
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
The new issue market produced a few inaugural deals the last week of October, including a 10-year bond for Acuity Brands (AYI). The proceeds of the new $500 million issue are to be used to repay the company’s existing $400 million term loan maturing 2023, with the remainder earmarked for general corporate purposes, adding some incremental debt to the company’s very strong balance sheet. Despite the additional debt, the new deal is positive for the credit as it extends the company’s maturity profile by seven years. The AYI is trading roughly 40 bp behind similarly rated peer IDEX Corp, despite boasting stronger credit and liquidity profiles. The trading differential between AYI 2.15% 12/15/30 bonds and IEX 3.0% 5/1/30 bonds is too wide and should collapse closer to 20 bp.
Given the size of the issue and the fact that it’s the only bond outstanding for the company, the deal was priced attractively relative to peers to garner interest. Even after the additional $100 million of debt, AYI remains in net cash position, that coupled with its free cash flow generation provides for solid financial flexibility to navigate the slowdown in the non-residential construction market since the pandemic started. It’s reasonable that IDEX Corp. (IEX – Baa2/BBB/BBB+) should trade through AYI as its end market diversification helps to limit cyclicality and provide for more stable revenue generation.
Exhibit 1: AYI vs. IEX Financial and Credit Profile Comparison
AYI is largely a lighting manufacturer that serves the commercial, institutional and infrastructure markets with both indoor and outdoor lighting and building management solutions. AYI maintains a portfolio of UV disinfection products and recently signed strategic agreements with Violet Defense LLC and Puro Lighting to expand upon this product portfolio. The agreements allow for AYI and PURO to use Violet Defense’s patented UV technology, in coming up with much needed and in demand UV disinfection lighting solutions for the post COVID world. AYI is looking at the partnerships to drive long-term solutions in an effort to create the most impactful technologies rather than as short –term market opportunity. As commercial buildings address the health and safety of its occupants, the solution will likely be some combination of UV disinfection lighting, IP and control technologies coupled with building management, all areas that AYI has made significant investments. The opportunity for these types of solutions has been rumored to be in the multi-billion range and AYI believes they are positioned to take a disproportionate share.
COVID-Era Renovations a Bright Spot
While new construction indicators remain weak, management noted that larger projects have come back online while smaller/medium sized construction projects continue to remain on hold. While these projects continue to be in a holding pattern, management said they have not seen any cancellations yet but would argue that some could get canceled should a second wave of the virus hit in a meaningful way. Importantly for AYI, their revenue mix is roughly 50% new construction and 50% renovation. The renovation market will likely continue to be a bright spot in 2021, a trend that AYI has witnessed for the past couple of years. Management is confident that they will see real opportunities in the renovation market particularly for hospitals, office spaces, restaurants, and the hospitality industry, both in UV disinfection lighting technology as well as more traditional renovation surrounding energy savings. Additionally, AYI noted they have seen an uptick in residential renovations as people have more time for do-it-yourself lighting projects given the shelter in place orders.
Margins Remains Largely Intact
Gross margin for fiscal 4Q was flat year-over-year at 42.1%, despite a 5% decline in revenues during the quarter. For the full fiscal year, AYI was able to expand the gross margin nearly 200 bp (to 42.2%), in the face of a 9% revenue decline. Management noted that economic pressure created by the pandemic led to oversupply in the market. AYI felt the prudent way to manage inventory supply was to make strategic investments in price versus a blanket type approach that many of their competitors took. This led to the maintenance/expansion of the gross margin while making market share gains. The adjusted EBITDA margin for the year totaled 14.9%, down only 30 bp year-over-year as SG&A expenses were relatively flat. For the past three fiscal years, AYI’s average adjusted EBITDA margin was 15.0%. Additionally, consensus estimates are calling for AYI to post an EBITDA margin of 14.7% for fiscal 2021, a 20 bp decline. While IEX has a much stronger margin profile, consensus estimates have IEX ending the year with and EBITDA margin of 25.9%, translating to a 230 bp decline year-over-year.