Description

LSI Industries, Inc. (LYTS) 

Summary 

We focus on smaller companies with “Ft. Knox” balance sheets and large & sustainable free cash flow yields and we are typically seeking a double-digit FCF yield or higher on an unleveraged basis. The objective is for the sustainable FCF to eventually drive up the share price to a more reasonable valuation through share buybacks, debt reductions, dividends, or accretive acquisitions. We must have a management team that cares about shareholder value. We focus on small-cap stocks because there is a much better chance of finding an attractive investment opportunity that is under-followed or undiscovered. 

LSI Industries (LYTS) provides corporate visual image solutions in the United States, Canada, Mexico, Australia, and Latin America.  It operates via two segments – Lighting and Graphic.  The Lighting segment manufactures and markets outdoor and indoor lighting and lighting controls for the commercial, industrial, and multi-site retail markets, including the petroleum/convenience store, quick-service, and automotive markets.  It primarily offers exterior area, interior, canopy, and landscape lighting, as well as light poles and photometric layouts; lighting system design services; and solid-state LED solutions.  This segment also designs, engineers, and manufactures electronic circuit boards, assemblies, and sub-assemblies for the manufacturing of LED light fixtures.  The Graphics segment manufactures and sells exterior and interior visual image elements used in graphics displays and visual image programs in various markets that include the petroleum/convenience store market, quick-serve restaurants, grocery, and multi-site retail operations.  Its products comprise signage and canopy graphics, pup dispenser graphics, building fascia graphics, fleet graphics, video boards, menu boards, and digital signage and media content management products.  This segment also provides installation management services for the installation of interior or exterior products.  LSI Industries, Inc. was founded in 1976 and is headquartered in Cincinnati, Ohio.

LYTS has several characteristics that we like including (1) a highly resilient business model with deep customer relationships, (2) a highly cash-generative business with low capital expenditure needs, (3) a strong focus on higher value-added services with longer-term and “stickier” customer relationships, (4) an attractive valuation trading at 8x adjusted EBITDA and a high single-digit free cash flow yield, (5) a focus on end-markets that are sustainably growing over the long term, (6) a record of strong sales growth - both organic and inorganic, over several years, (7) a disciplined management team focused on driving organic growth via new products and solutions that are highly engineered as well as accretive acquisitions, (8) a “Ft. Knox” balance sheet with net debt at under 1x adjusted EBITDA, (9) a long-term strategy to grow sales and EBITDA, and (10) a high-ROIC business model with limited capital requirements.

Over the past 5 years, under CEO Jim Clark, who joined LYTS in November 2018, the Company has shifted its business model away from commodity, “off-the-shelf” products and solutions to higher value-added products and relationships with customers with higher margins and longer contract periods.  LYTS has focused on highly engineered and designed solutions to deeply integrate into its customers.  LYTS also focused on specific market verticals and industries with strong long-term growth potential.  LYTS eliminated lower-margin work and removed revenue contracts with lower-margin profiles.  

Two primary drivers of LYTS’ improved growth and financial results have been more highly engineered products and solutions and a vertical market focus, as summarized below.  LYTS solutions for its vertical markets represent higher value-added and stickier and longer-term relationships with customers, as described below.  LYTS has carefully selected vertical markets that are growing and resilient and where its products and solutions can add significant and differentiated value for its customers.  These include Refueling & C-Store, QSR, Retail & Grocery, Automotive, Warehouse, Parking, and other vertical markets.  LYTS will often develop a highly customized solution for one customer in a specific vertical and then leverage it across the entire industry with other customers.

LYTS has an attractive valuation, especially given its recent growth profile, driven by its vertical market and valued-added solutions strategy.  From FY20 (ended 6/30) to FY23, LYTS grew revenues at an 18% CAGR and adjusted EBITDA at a 48% CAGR and adjusted EPS at an 88% CAGR.  LYTS has 30m shares outstanding trading at about $14 per share for a market cap of about $420m.  LYTS has net debt at 9/30/23 which will soon be zero.  LYTS will soon have an enterprise value of about $420m (zero net debt assumed) which versus LTM adjusted EBITDA of about $53m or is about 8x LTM adjusted EBITDA.  Further, LYTS earned adjusted EPS of about $1 per share in FY23 which compares to its current price of about $14 per share or about 14x.  

We believe these multiples are modest and remain extremely attractive given LYTS’ strong growth in revenue, adjusted EBITDA, and adjusted EPS over the past 5 years under CEO Jim Clark and his team.  We believe the market has not recognized LYTS’ resilient and cash-generative business model and “sticky” customer relationships.  As LYTS continues to execute and grow organically and inorganically, we believe the market will eventually reward LYTS with higher earnings multiples.

We believe LYTS can continue its strong growth trend over the last few years in revenues, adjusted EBITDA, and adjusted EPS.  LYTS originally projected to achieve revenues of $500m and adjusted EBITDA of $50m by FY25 and achieved these results two years early in FY23.  CEO Jim Clark and his team, rather than resting on their laurels, quickly produced an updated 5-year plan that targets revenues of $800m and adjusted EBITDA of $100m, for a 12% adjusted EBITDA margin, by FY28.  CEO Clark and his team expect to achieve approximately half of this growth organically and half from strategic, tuck-in acquisitions.  We believe LYTS can achieve these FY28 targets with its highly resilient, customized product business model, and increasingly strategic relationships with major customers.  LYTS is laser-focused on highly engineered and proprietary products which differentiate them from commodity lighting suppliers and allow them to develop long-term strategic relationships with a very impressive customer list (see below).  

We note that LYTS has indicated results for FY24 may be impacted by deferred capital programs by major grocery chains (the two largest chains are involved in merger discussions) and, consequently, we believe growth for Q2 and Q3 of FY24 could be fairly modest and investors should position themselves accordingly.  However, we have strong confidence in the multi-year outlook given the quality of the business model and the management team’s execution over the last 5 years under CEO Jim Clark.

We believe LYTS can achieve adjusted EBITDA of $100m or more in FY28 and its highly cash-generative business model can trade for 10x adjusted EBITDA with zero net debt for a market cap of about $1b.  Based on 30m diluted shares outstanding, this would result in a price of about $33 per share versus the current price of about $14 per share.  Further, we believe LYTS’ strategic and diversified manufacturing platform and long-term customer relationships could be attractive to either a strategic or financial purchaser.

Business Description

Overview

LSI Industries Inc. (LSI) is a leading producer of non-residential lighting and retail display solutions. Non-residential lighting consists of high-performance, American-made lighting solutions. The Company’s strength in indoor and outdoor lighting applications creates opportunities for LSI to introduce additional solutions to its customers. Retail display solutions consist of graphics solutions, digital signage, and technically advanced food display equipment for strategic vertical markets. LSI’s team of internal specialists also provides comprehensive project management services in support of large-scale product rollouts.

Our business is organized as follows: the Lighting Segment, which represented 55% of FY23 net sales, and the Display Solutions Segment, which represented 45% of FY23 net sales. Net sales by segment are as follows:

Lighting Segment

Lighting Segment manufactures, markets, and sells outdoor and indoor lighting fixtures and control solutions in the following vertical markets: refueling and convenience stores, parking lots and garages, quick-service restaurants, retail, grocery and pharmacy, automotive dealership, sports court and field, and warehouse. LYTS services these markets through multiple channels: project business sold through electrical distributors and agents and shipped directly to the customer; standard products sold to and stocked by distributors; and direct to end-user customers. The products are designed and manufactured to provide maximum customer value and meet the high-quality, competitively priced product requirements of the markets served. Focusing on key vertical applications allows LYTS to deliver unique product solutions, which in turn provide differentiated value to customers.

LYTS’ lighting fixtures, poles, and accessories are produced in a variety of designs, aesthetics, and finishes.  Application of lighting fixtures varies to include surface, pole, and pendant-mounted applications.   Functional light distributions from our products vary depending upon the application providing application-specific photometric outputs including, but not limited to, interior and exterior downlighting, wall-wash lighting, canopy lighting, floodlighting, emergency exit lighting, industrial lighting, area and parking structure lighting, and security lighting.  To further energy efficiency gains from luminaires, LYTS offers a suite of lighting control options including sensors, photo controls, dimming, motion detection, and circuit controllers in both analog and wireless technologies to further support the application of our luminaires and provide means to additional energy savings   LYTS designs and certifies all applicable safety, photometric and performance standards including UL Solutions, Design Lights Consortium, International Dark-Sky Association, Norma Official Mexicana (NOM), and Institute for Printed Circuits (IPC).  Utilizing LED light sources, products are designed for energy efficiency, reliability, performance, ease of installation, and service while providing a high degree of overall aesthetic appeal.  LYTS focuses on providing performance-based, energy-efficient lighting solutions implemented across all key vertical markets served. 

Display Solutions Segment

The Display Solutions Segment manufactures, sells, and installs exterior and interior visual images and display elements, including printed graphics, structural graphics, digital signage, menu board systems, store display fixtures, refrigerated displays, and custom display elements. The major products and services offered within the Display Solutions Segment include signage and canopy graphics, pump dispenser graphics, building fascia graphics, decals, interior signage and marketing graphics, aisle markers, mural graphics, and refrigerated and non-refrigerated merchandising displays. LYTS also provides a variety of project management services to complement our display elements, such as installation management, site surveys, permitting, and content management which are offered to customers to support digital signage. LYTS also manages and executes the implementation of large rollout programs with our professional services group. These programs provide customers with a variety of display solutions and visual image upgrades in the same markets served in the lighting segment, which includes the following markets: refueling and convenience stores, quick-service restaurants, retail, grocery and pharmacy, and automotive dealerships. LYTS believes our expertise with the products and services we offer in the markets we serve represents a significant competitive advantage. LYTS works with customers and design firms to establish and implement cost-effective corporate visual image programs to advance its customer’s brands and deliver value to their customers. Increasingly, LYTS has become the primary supplier of exterior and interior visual image and display elements for its customers.

Sales, Customers, and Marketing

The products and services offered are sold primarily throughout the United States, but also in Canada, Mexico, and Latin America (approximately 4% of consolidated net sales are outside the United States). LYTS’ lighting product sales originate from two primary revenue streams. The first revenue stream is from project-based business, quoting and receiving orders as a preferred vendor for product sales to multiple end-users, including customer-owned as well as franchised and licensed dealer operations. The second revenue stream is from selling standard products to stocking distributors, who subsequently provide products to electrical contractors and end users for a variety of lighting applications. The lighting products are primarily sold through the manufacturer’s sales representatives and to a lesser degree directly through its internal sales force. The display solution elements and related services, which in many instances are program-driven, are sold primarily through its internal sales force. This revenue stream is from more significant program initiatives that often represent multiple sites over some time. These customers are usually established and have a long-term relationship with LSI. These products and services are sold directly to the customer or a brand marketer acting as an intermediary.

The Company markets its products and service capabilities to end users in multiple channels through a broad spectrum of marketing and promotional methods, including direct customer contact, trade shows, on-site and virtual training, print advertising in industry publications, product brochures, and other literature, e-learning, the company’s website, as well social media. The marketing approach and means of distribution vary by product line and by market.

Manufacturing and Distribution

LYTS currently operates out of eleven manufacturing facilities located within six U.S. states and one province in Ontario, Canada.

LYTS designs, engineers, and manufactures most of its lighting and visual display products through the utilization of lean manufacturing principles. Its investment in our production facilities is focused primarily on improving capabilities, product quality, and manufacturing efficiency, as well as environmental, health, and safety compliance. The majority of products it sells are engineered, designed, and assembled by the Company, while a small portion of the products and components we sell are purchased from select qualified vendors. The lighting and display solutions products are delivered directly from its manufacturing facilities to its customers utilizing third-party common carriers.

Research and Development:

The Company invests in the development of new products and solutions as well as the enhancement of existing product offerings to meet the needs of its customers. Research and development costs are directly attributable to new product development, including the development of new technology for both existing and new products, and consist of salaries, payroll taxes, employee benefits, materials, outside legal costs, and filing fees related to obtaining patents, supplies, depreciation, and other administrative costs. Research and development costs related to both product and software development totaled $3.4m and $3.6m for FY23 and FY22, respectively.

Competition

LYTS experiences competition in both segments and in all markets served based on numerous factors, including price, brand name recognition, product quality, product design, prompt delivery, energy efficiency, customer relationships, reputation, and service capabilities. Although LYTS has many competitors, both nationally and internationally, some of which have greater financial and other resources, LYTS does not compete with the same companies across both segments and all markets.

Highly Resilient Business Model 

LYTS has a highly resilient business model with deep customer relationships.  Over the past 5 years, LYTS has shifted its strategy towards growing more highly engineered products and services under Jim Clark and his team since May 2018.  It has built deeper relationships with customers by becoming more integrated with their business models and strategies.  These long-term, design and engineering-driven, higher value-added relationships with customers are much “stickier” and resilient in response to adverse macroeconomic trends.  We believe LYTS has become more of a strategic partner to its customers over the last 5 years.  We believe LYTS business is more predictable given the stronger and deeper relationships with customers.

Attractive Valuation

LYTS has an attractive valuation, especially given its recent growth profile, as it has focused on value-added and customized solutions for its customers to develop more strategic and longer-term relationships.

LYTS has 30m shares outstanding trading at about $14 per share for a market cap of about $420m.  LYTS had net debt at 9/30/23 of about $21m.  We expect LYTS will soon have an enterprise value of about $420m (no debt) which compares to LTM adjusted EBITDA of about $53m, or about 8x adjusted EBITDA.  Further, LYTS earned adjusted EPS of about $1 per share on an LTM basis which compares to its current price of about $14 per share or about 14x.  

We believe these multiples are modest and remain extremely attractive given LYTS’ strong growth in revenue, adjusted EBITDA, and adjusted EPS over the past few years.  We believe the market has not yet recognized LYTS’ more resilient and predictable business model which it developed over the several years under CEO Jim Clark.  As LYTS continues to execute and grow both organically and inorganically, we believe the market will eventually recognize LYTS with more appropriate earnings multiples.

Highly Cash Generative Business with Low Capital Expenditure Needs

LYTS has a highly cash-generative business with low capital expenditure needs. The Company has an attractive unleveraged FCF yield in the high single-digit range.  We believe on a normalized basis, LYTS can generate $30m to $40m of free cash flow per year.  Capital expenditure is very modest at less than 1% of total sales. The Company has generated almost $100m of cumulative cash from operations over the past 4 years, or close to 25% of the enterprise value despite cash flow headwinds from the pandemic.  Also, LYTS has modest capital expenditure requirements (1% or less of revenues per year).  LYTS has completed successful strategic acquisitions with its strong free cash flow.  This strategic acquisition (JSI) has enabled LYTS to significantly strengthen its business model and its resiliency. Due to strong performance, LYTS has been able to deleverage its balance sheet after the JSI acquisition and is well-positioned for additional accretive M&A opportunities.  

Strong Growth in Revenues, Adjusted EBITDA, and Adjusted EPS

Over the past few years, LYTS has shown strong growth in revenues, adjusted EBITDA, and adjusted EPS.  

LYTS has an attractive valuation, especially given its recent growth profile, driven by its vertical market and valued-added solutions strategy.  From FY20 (ended 6/30) to FY23, LYTS grew revenues at an 18% CAGR and adjusted EBITDA at a 48% CAGR and adjusted EPS at a CAGR of 88%.  This includes the successful acquisition of JSI in May 2021 which enabled LYTS to integrate further into interior space in Refueling & C-Store and Grocery and Retail with customized solutions for customers.  

While we expect growth to moderate in FY24 as LYTS laps these strong results, we believe LYTS can continue to grow over time as it executes its new-product, engineering-led growth strategy to drive organic growth and takes advantage of its “Ft. Knox” balance sheet (almost debt-free) to add strategic bolt-on acquisitions.

“Ft. Knox” Balance Sheet

LYTS has a “Ft. Knox” balance sheet with $4m in cash and $25m of total debt or net debt of $21m at 9/33/23. Net debt to adjusted EBITDA is less than 0.5x LTM adjusted EBITDA.  LYTS has reduced leverage after the successful acquisition of JSI in May 2021 and an excess working capital position to deal with supply chain issues post-Covid which continues to normalize.  We believe LYTS is well-positioned to make further accretive acquisitions like JSI Limited and drive additional shareholder value.  Its “Ft. Knox” balance sheet reduces risk and enables LYTS to take advantage of strategic opportunities. 

Focus on Verticals Sustainably Growing Over the Long-Term

LYTS has carefully selected to specialize in vertical industries where it can add value to customers, and which are growing and resilient.  These include Refueling & C-Store, Grocery, QSR, Automotive, Warehouse, Parking, and others.  Lighting products can be critical to driving customer traffic to these customers and can be a major competitive factor in growth.  The average life cycle of lighting solutions has become increasingly shorter over time in many of these industries, reducing from almost 7 years in QSR to 5 years and even less.  Lighting solutions can be a significant source of critical differentiation to drive customer traffic flows over time.  LYTS’ customized solutions are typically highly engineered with extensive customer input such that the Company can become a strategic partner with these customers over time and create a stickier and longer-lasting relationship.

Disciplined Management Team Focused on Accretive Acquisitions

We have observed CEO Jim Clark and the management team of LYTS for several years.  We believe they are highly disciplined with a strong focus on resiliency, profitability, and return on invested capital.  We believe they are an exceptional management team with an excellent long-term strategy.  They have shifted the business model to more customized and higher-value-added products and services.  They have built long-term, multi-year relationships with major customers.  They have executed one highly successful and accretive acquisition, JSI, in May 2021.  They have paid down net debt after the JSI acquisition to position themselves for additional accretive M&A opportunities.  We believe they have executed well during the supply chain problems and COVID-19 pandemic issues.  

Focus on Higher Value-Added Services with Stickier Relationships with Customers 

LYTS has adopted a higher value-added and more customized product and service strategy with customers under Jim Clark’s leadership since May 2018. strategy over the past 5 years and these relationships are higher-value-added, higher-margin, and more resilient with customers.  These sales relationships are more deeply integrated with LYTS as a strategic partner to customers rather than a supplier of commodity goods and services.  The result has been more stable and predictable revenues, profits, and cash flows as LYTS has implemented its highly engineered and new products and services programs with major customers.  We believe the customer relationships are more recurring and “stickier” than the market realizes and LYTS could trade at higher multiples as this dynamic is recognized.  Further, while LYTS is a project-based business model, the industries that it serves require constant maintenance and upgrading capital expenditures to remain competitive and drive customer traffic. 

Conclusion

We believe LYTS can achieve adjusted EBITDA of $100m or more in FY28 and its highly cash-generative business model can trade for 10x adjusted EBITDA with zero net debt for a market cap of about $1b.  Based on 30m diluted shares outstanding, this would result in a price of about $33 per share versus the current price of about $14 per share.  Further, we believe LYTS’ strategic and diversified manufacturing platform and long-term customer relationships could be attractive to either a strategic or financial purchaser.

Quarterly Financial Results

Catalysts

• Highly cash-generative business model.
• Low valuation at 8x adjusted EBITDA and 14x adjusted EPS 2023
• Attractive free cash flow yield in high single digits.
• Continued steady growth of revenues, adjusted EBITDA, and adjusted EPS.
• Business model is resilient, not recognized in market valuation.
• Long-term and deeply integrated customer relationships are significant barriers to entry.
• Excellent management team focused on shareholder value.
• Strong track record of highly accretive acquisitions.
• “Ft. Knox” balance sheet.
• Further accretive acquisitions like JSI 

Risks

• Severe downturn in U.S. and global economies
• Business segments less resilient than expected 
• Poor acquisition which hurts shareholder value

Catalyst

See above.