Description

INVESTMENT THESIS     

LSI Industries, Inc. (“LYTS” or the “Company”) is a much higher quality business than perceived, trading at a substantial discount to its appropriate value with multiple near-term catalysts. LYTS has undergone a major transformation over the last four years that has changed the business and resulted in a more attractive customer base, much higher margins, longer-term and recurring contracts, higher returns and reduced leverage. The Company is now the clear leader in lighting and signage to national C-stores, gas stations, grocery chains and supermarkets. All three of these industries are performing very well and are making increasing investments that are benefiting LYTS. These secular tailwinds are manifesting themselves in record order backlogs and bidding activity, new projects wins and an acceleration in revenue growth for the Company. A lack of institutional following, limited corporate communication and an underappreciation of LYTS’s improved profile have resulted in a significant price-value disconnect. Recent forced selling and misplaced perceived industry challenges due to earnings weakness from a peer have presented a very attractive buying opportunity. Last week six insiders acquired shares. 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 the following.

1. Russell 2000 Index inclusion: To be announced in May with formal addition in June. The market cap threshold for addition is estimated to be $150-160M versus LYTS which is currently $383M. Although technical in nature, this should boost its trading liquidity, profile and require index buying. 
2. Financial outperformance: Driven by new contracts, end-market strength and a higher margin revenue mix. Such sustained results should lead to increased appreciation for the quality of the business. Rebranding and signage associated with the mergers of Kroger (KR)-Albertsons (ACI) with 655 locations and BP-TA with 290 locations will be very large incremental opportunities for LYTS. All four are existing LYTS customers.
3. M&A: Increasing likelihood of an outright sale of the Company following the recently announced five-year targets and state of the business overhaul. This is an asset that would be logical for much larger Acuity Brands (AYI) or Hubbell (HUBB) to acquire given the product overlap/ vertical integration opportunity and expand end-market exposure of either. Both parties have announced M&A intentions. Further, the CEO relocated to run the business five years ago and had previously indicated a desire to turn the business around and then sell as he did in his prior leadership assignments. The CEO also comes from a PE background, a group that typically has 5–7-year investment horizons (he and several of the members of his executive he hired are approaching the 5-year anniversary of their tenure at the Company).
4. Increased corporate communication: The Company has historically had limited investor outreach but management has indicated that with much of the operating improvements behind them, they will be pursuing additional sell-side coverage and increasing corporate communication by attending investor conferences (scheduled to present at the Craig-Hallum conference next month).

BUSINESS OVERVIEW & REVENUE DRIVERS

LYTS provides digital and conventional signage and lighting to commercial and retail customers in North America. Its largest customers include QSRs (Wendy’s, Popeyes, Burger King, Starbucks), retail/ grocery (Kroger, Albertsons, Whole Foods, CVS), C-Stores/ retail petroleum (7-Eleven, BP, Exxon Mobil, Chevron, Shell), auto dealerships (Nissan, Honda, CarMax) and larger municipalities and institutions. The Company’s projects are primarily comprised of national overhauls across a customer’s franchise base. This work typically lasts 4-5 years per project and involves replacement of illuminated external signs, displays and internal digital signage, displays and lighting. Historically QSRs, gas stations, grocery stores and C-stores undertook such projects every 7-10 years. Consolidation, industry trends and an accelerated use of technology has led to nearly continuous refresh cycles. Several of LYTS contracts have been nearly perpetual as once one region is complete another is in need of replacement. The operating life of most exterior lighting is 5-7 years thus has a regular replacement cycle even absent a broader store refurbishment. Further, some of its major customers are franchise models where the franchisor mandate store renovations across their networks. LYTS is contracted for this work on a regional or national basis by the franchisor with the cost borne by the franchisee.

The Company’s customers are all multi-unit operators. These companies want to maintain a consistent brand image, appearance and lighting environment across all 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). There is no other national operator at LYTS’s scale specializing in its end-markets. For many of these customers, the Company is the sole lighting and signage provider. Its successful inventory management post-Covid while supply chain constrained competitors faltered enabled it to further strengthen its market position. We learned that LYTS continues to benefit from these dynamics and recently won a contract in part because the other bidder had a 46-week lead time due to product and labor shortages. The Company has proven to be a superior operator in this somewhat niche industry.

• Grocery: The Company’s 2021 acquisition of JSI expanded its presence and exposure to grocery stores. This category has been prioritizing fresher, healthier read-to-eat product displays. This was JSI’s focus and has enabled LYTS to leverage its existing relationships with national grocers to win new projects with customers such as Whole Foods and Fresh Market. The consumer shift toward pick-up and delivery services also continues to benefit LYTS. The primary contributing factors being an increased need for drive-in and curbside pick-up and associated signage and digital menu boards. Several of its existing grocery customers have expanded their 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. The previously mentioned industry consolidation will necessitate rebranding where LYTS is the incumbent provider.  
• Retail Petroleum and C-stores: Another major tailwind benefiting LYTS comes from the strength of gas stations and C-stores. Retail fuel margins were historically in the mid-20cpg but then rose significantly over the last two years and are now 40cpg nationally. This phenomenon has persisted and led to a major windfall for gas station operators. Unclear if this is a structural shift from consolidation in the sector but margins have shown few signs of reverting. Gas station and C-store chains are in a position of financial strength and reinvesting with an emphasis on food and store expansion, upgrades to more energy efficient lighting, merger-related rebranding, refurbishment and store upgrades.
• QSRs: Fast-casual dining chains have also experienced a bit of a boon over the last two years and after a dearth of upgrades during Covid, are now upgrading signage and ordering systems. The Company recently won a multi-year contract to overhaul Popeye’s interior signage, drive-through displays and menu boards. This represents a $20-30k revenue opportunity per location for LYTS (Popeyes has over 2,500 domestic units). This comes on the back of ongoing programs with Burger King, and Wendy’s, among others.    

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 divested several facilities.

FINANCIAL PROFILE & VALUATION

The improved project and customer mix in the business concurrent with the operating and financial improvements have transformed the business profile. Further margin upside should come as its mix-shift to larger, higher return, more specialized programs continue. (Note: June fiscal year-end.)

Last month the Company set out new longer-term financial targets. When management previously put out such guidance, LYTS ultimately performed ahead of forecast by nearly two years. Management has historically been very conservative in setting expectations and consistently beaten guidance. Concurrently the stock came under pressure due to the force-selling by a liquidating fund and weaker earnings results from peer Acuity Brands despite that fact that Acuity’s challenges were related to end-markets in which LYTS has almost zero exposure.

On a fully-taxed basis we believe LYTS will generate $1.25-$1.45 of cash EPS over the next four quarters. This equates to an approximately 9-10x cash EPS or an 10-12% 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 has historically traded at a mid-teens forward earnings multiple with a larger skew to less attractive commercial segments 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 14-15x EPS multiple, the stock would trade at $20-22 per share or 50-70% above the current price. This assumes no further acquisitions. 

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 and Hubbell (HUBB) to engineering services and construction companies like Fluor (FLR) or Tetra Tech (TTEK). All trade at high-teens to mid-twenties EPS multiples making an acquisition of LYTS at $25 per share accretive.

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 operations and sales, among several management level changes.
• Commercial Construction Slowdown: C&I lending activity and office real estate construction is a headwind for lighting manufacturers such as Acuity Brands. The Company has very limited exposure to that area of commercial construction and overall new building, its end-markets remain very strong and to a large degree, lighting replacement is a non-discretionary expenditure.

Catalyst

• Russell 2000 Index inclusion
• Financial outperformance
• Sale of the company
• Increased corporate communication