Earnings Recap - Orion Energy Systems (OESX)

We are long Orion Energy Systems (Nasdaq: OESX), which on February 6th issued its earnings report for the 3rd quarter (12/31/19) of its fiscal 2020 (link here). OESX is a provider of LED lighting and turnkey energy project solutions designed to reduce energy consumption and enhance business performance and efficiency. Orion designs, manufactures, markets and manages the installation and maintenance of LED solid-state lighting systems, along with integrated smart controls. Overall financial performance for OESX remains in a strong uptrend, with revenues and earnings in the most recent quarter up *bigly* over the respective prior-year periods--below are the highlights:

The main driver of the recent outstanding performance for OESX was a large turnkey LED project win with a major national account, which has been responsible for over 70% of FY20's revenues YTD (and will likely be responsible for the vast majority of Q4's revenues as well). Our understanding is that this project is for the installation of lighting resembling the following:

The company has guided to full-year revenues of between $150 and $155 million, with "at least" a 10% EBITDA margin. This implies that at the absolute worst, Q4 of FY20 would be break-even on an EBITDA basis (since EBITDA for the 1st 9 months of FY20 was nearly $15MM). We certainly hope the company generates positive EBITDA (and is hopefully profitable) in Q4, however nothing in investing is certain, especially given the sourcing disruptions going on in China currently.

At a recent market cap of $184MM (31MM shares outstanding, $5.98 stock price at 2/14/20) and minimal debt, OESX trades at around 1.2X P/S, which would be considered extremely cheap *IF* its recent revenue trends were even remotely sustainable over the longer term. Much larger peer Acuity Brands (NYSE: AYI - $4.6B market cap, or 25X the size of OESX), for example, has a higher P/S ratio at ~1.3X (source), yet in its most recent quarter AYI's sales were actually down over 10% (versus up 110% for OESX) (source). The real question for OESX (and why people who are selling at current prices are doing so, despite the apparent P/S cheapness) is whether its recent contract wins will be exhausted in the near term, with little in the sales pipeline to replace them.

Admittedly (and this is an easy admission to make, admittedly) we bought in to OESX at prices far below the recent stock price of around $6/share--in fact, we bought our stake in late 2018 at an average price of $0.72/share. So why stay long after such a rise, especially given the uncertainty regarding the company's pipeline and the sustainability of its revenues? Two reasons: (A) leadership and (B) LED's secular growth story. On the first point, OESX has executed brilliantly ever since current CEO Mike Altschaefl took over in mid-2017 (see PR announcement here). Generally speaking, as an investor you want to ride a good horse as long as possible (think Buffett/BRK, Ellison/ORCL, Musk/TSLA, Hastings/NFLX, etc.) Here is the full bio for CEO Altschaefl (source):

Michael W. Altschaefl, 60, was appointed as OESX's chief executive officer on May 25, 2017 and has served as a director since October 2009. Mr. Altschaefl has served as OESX's board chair since August 2016. Mr. Altschaefl serves as the chairman of E-S Plastic Products LLC, a custom manufacturer of plastic injected molded parts and PanelTEK LLC, an electrical engineering services and custom manufacturer of electrical control panels. Mr. Altschaefl served as the president and chairman of Still Water Partners, Inc., a private investment firm, from August 2013 through December 2017 and as president of E-S Plastic Products LLC from November 2013 through May 2017. Previously, Mr. Altschaefl served as the vice president—strategy and business development of Shiloh Industries, Inc., a public company and leading independent manufacturer of advanced metal product solutions for high volume applications in the North American automotive, heavy truck, trailer and consumer markets from January 2013 until October 2013. Mr. Altschaefl was an owner and chief executive officer of Albany-Chicago Company LLC, a custom die cast and machined components company when Shiloh Industries purchased the company in December 2012. Mr. Altschaefl is a certified public accountant. Prior to acquiring Albany-Chicago Company LLC in 2008, Mr. Altschaefl worked for 27 years with two international independent registered public accounting firms, including 16 years as a partner.

Second, OESX's recent strength has followed the reorientation of its business model to focus on the sale of LED lighting and related IoT controls, as opposed to incandescent or fluorescent lighting. OESX's main products are the following (source):

The LED Troffer Door Retrofit (LDRTM): The LDRTM is designed to replace existing 4 foot by 2 foot and 2 foot by 2 foot fluorescent troffers that are frequently found in office or retail grid ceilings. Our LDRTM product is unique in that the LED optics and electronics are housed within the doorframe that allows for installation of the product in approximately one to two minutes. Our LDRTM product also provides reduced maintenance expenses based upon improved LED chips.

Interior LED High Bay Fixtures: Our LED interior high bay lighting products consist of our Harris high bay, ApolloTM high bay and ISON® high bay products. Our ISON® class of LED interior fixture offers a full package of premium features, including low total cost of ownership, optics that currently exceed competitors in terms of lumen package, delivered light, modularity and advanced thermal management. Our third generation of ISON® class of LED interior fixture delivers up to an exceptional 214 lumens per watt. This advancement means our customers can get more light with less energy, and sometimes fewer fixtures, compared to other products on the market. Our ApolloTM class of LED interior fixtures is designed for new construction and retrofit projects where initial cost is the largest factor in the purchase decision. Our Harris high bay is ideal for customers seeking a cost-effective solution to deliver energy savings and maintenance reductions. In addition, our LED interior lighting products are lightweight and easy to handle, which further reduces installation and maintenance costs and helps to build brand loyalty with electrical contractors and installers.

Smart Lighting Controls. We offer a broad array of smart building control systems that have either been developed by us under the InteLiteTM brand or procured from third parties. These control systems provide both lighting control options (such as occupancy, daylight, or schedule control) and data intelligence capabilities for building managers to log, monitor, and analyze use of space, energy savings, and provide physical security of the space.

LED lighting is currently in a secular growth trend, as per industry research and reports (source):

LED lighting is vastly superior to other forms of lighting, since LED bulbs only need to be replaced every 5 to 10 years (depending on usage) and use far less electricity per-hour used, meaning they save people serious money--see further discussion here. OESX's management has stated that customer pay-back periods for LED projects handled by the company can be as little as one year. This incentivizes the growing adoption of this type of lighting, which we think OESX should be able capitalize on robustly over the next 5-10 years and beyond. In addition, on the recent earnings conference call (link can be found at OESX's IR website) an analyst covering the company strongly implied that market leader AYI was panicking that OESX was on the verge of poaching one of AYI's top-5 customers. Thus, OESX seems poised to capture market share (in addition to simply participating in LED lighting's secular adoption curve). The recent on-boarding by OESX of four additional salespeople suggests that management is quite bullish about future contract wins.

If OESX can plateau over the near term at a net income level of ~$15-20MM/year (up slightly from FY20's expected level), this would justify a share price of ~$10.75 at the midpoint of this range (assuming a 20 P/E and minimal dilution). Therefore we see ~80% upside in the stock if a combination of market share gains plus general increased LED adoption puts a firm floor under OESX's FY2020 revenue run-rate going forward. Over the longer term, we think that under current management OESX can substantially increase earnings as more and more contract wins are obtained (the recent win with OESX's large national account and the satisfactory performance of this contract should set a precedent, as well as an advertisement for potential customers, in the marketplace). In either case, the future certainly looks bright (pun intended) at OESX.

P.S. - You can follow OESX on Twitter at the following account: https://twitter.com/OrionLightingIR

Disclosure: Long OESX.