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LSI Industries, Inc. (“LYTS” or the “Company”) presents an opportunity to invest in a business benefiting from multiple secular tailwinds and significant operational improvements that will drive fundamentals and stock performance over the coming quarters. Lack of sell-side coverage and limited institutional following has led to an underappreciation of these facts. We believe that the stock will trade +75% over the next year as this reality is illuminated to the market. The setup here is somewhat reminiscent of the dynamics facing At Home (HOME) when we wrote it up in June.
Overview and Secular Drivers
LSI manufactures and installs indoor and outdoor digital signage and lighting systems primary to larger national commercial customers. The Company’s clients are concentrated in the QSR, grocery, gas station/ c-store, retail and auto dealership sectors. As you can see, they are all well-established, high quality, growing franchises including Starbucks (SBUX), CVS (CVS), Wendy’s (WEN), Exxon Mobil (XOM), 7-Eleven and CarMax (KMX).
LSI is vertically integrated and one of the largest national providers of lighting and signage with a leading market share in each of the verticals in which it participates. This affords it a number of competitive advantages over smaller regional operators as 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). Brands are regularly modifying and upgrading their signage to differentiate and attract traffic. The average replacement cycle of a digital sign is 5-7 years with the average contract spanning 4-5 years. The duration of LSI’s projects and frequency of its customers’ refreshes means the business has a somewhat consistent level of recurring revenue.
Distancing is driving a number of changes in consumer behavior that benefit LSI. The primary contributing factors being an increased need for drive-in and curbside pick-up and associated signage as well as digital menu boards. Grocery stores are rolling out 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. A consumer analyst recently observed the following:
BOPIS has become a new habit for many consumers. Covid has gone on long enough for consumers to form new habits in terms of both where they shop and how they shop. BOPIS will always be the cheapest same day delivery service because the consumer is effectively paying for the cost of the delivery by driving themselves to the store. Definitionally, category leading retailers have fairly optimal store locations for BOPIS and in-store returns. It would not surprise me to eventually see BOPIS hubs emerge at malls and shopping centers. (Source: Gavin Baker – medium.com/@gavin_baker)
Meanwhile QSRs are experiencing strong drive-through demand and are expanding these services by adding lanes, ordering stations and service windows. This undertaking requires addition signage and digital menus.
Underappreciated Business Improvements
Two years ago a new CEO, Jim Clark, took over LSI. He was previously the head of Alliance Tires Americas with additional senior roles at PE firm Dunes Capital, GE and United Technologies. He has subsequently overhauled the Company by way of the following iniatives:
- Upgrading of the management team including a new CFO, head of operations and head of sales.
- Exiting of lower quality categories and customers (primarily traditional print) and focusing on higher value added products.
- Adopting of lean manufacturing and other operating expense reduction programs.
- Rationalizing production footprint and right-sizing of capacity.
- Improving purchasing discipline and working capital management.
- Reducing $8-10M of overhead.
- Consolidated and sold-off several facilities, including last quarter’s sale of its Canton, OH facility for $8M.
The result: The business has transformed from its legacy of lower price discipline and focus on sales volumes to a much more efficient and profitable organization. The Company’s LTM EBITDA margin is 5.0% versus 3.2% in 2018. In the MRQ, despite Covid-19 impacts LSI reported a record EBITDA margin of 7.0%, a 120% increase from the period before Jim Clark took the helm. He and his team have increased FCF by 40% through margin expansion, working capital improvement (net working capital down 20%) and asset sales. This has enabled LSI to reduce it leverage ratio from 3x in 2018 to net cash in the most recent quarter.
LYTS is on track to generate $0.70-$0.75 of cash EPS over the next twelve months. This equates to an approximately 9-10x cash EPS based on the current share price. The closest peer in terms of products and end-market, Acuity Brands (AYI), currently trades at a mid-teens forward earnings multiple. The broader commercial construction services and equipment sector trades in the mid-to-high teens. At a more appropriate 15-17x EPS multiple, the stock would trade at $11-12 per share or 50-70% above the current price. This assumes no further monetization of its facilities.
- Financial performance from new contracts (in April announced a $100M program to overhaul Wendy’s 6,000 restaurants over the next couple years) and higher margin revenue mix.
- Increased appreciation for the improved quality of the business and earnings profile.
- Additional asset sales (still own 7 facilities).
- Accretive acquisitions or de novo expansion into other lighting and signage verticals.
- Improved corporate communication and investor outreach.
- Potential outright sale of the business to a commercial construction and design company.
Disclosure: I am/we are long LYTS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.