Let There Be Light

Acuity Brands (AYI) is cashing in nicely on the boom. It makes a wide variety of lights: exit signs, track lighting, antique street lamps, fluorescent ceiling lights and so on. It also makes chemical products like floor finishes, drain cleaner, pesticides and degreasers. Acuity shares are up 37% so far this year, and there's reason to believe they're headed higher. The company turned up recently on our Unheard Of screen.

The Unheard Of screen is designed to find promising, fast-growing companies before most of Wall Street does. It does so by looking for things like modest stock valuations and recent upside earnings surprises, along with limited analyst coverage. Not all the companies it identifies are upstarts, or even young. Acuity owns companies that have been in business for more than 60 years, and produced more than $2.3 billion in sales over the past year. But its operational momentum and relatively sparse analyst coverage is nonetheless a good sign. New analyst coverage is more often positive than not. The two firms that have initiated coverage of Acuity in the past year have both done so with favorable ratings. That tends to drive share prices higher. Find companies with little attention from analysts today but with results that suggest they'll attract more tomorrow, and you've likely found some bargain stocks.

Use our stock screener and Unheard Of screen recipe anytime to run our search for yourself. Recently it produced a list of eight companies from a starting database of 8,000. Let's look at Acuity.

Based in Atlanta, Acuity sells lighting under brands like Lithonia, Holophane, Peerless and Gotham and chemicals under the brands Zep, Enforcer and Zelig. Its products are bought by big construction companies for specific projects and by resellers like Home Depot (HD). If the company's products have a janitorial theme it's no coincidence. Acuity is the result of a November 2001 spinoff from now privately held National Service Industries in Atlanta, which rents and washes linens for restaurants, hotels and hospitals and makes custom envelopes and office supplies. Since the spinoff Acuity shares have gained more than 250%.

Acuity's fiscal third-quarter results, released July 6, contained little for investors to complain about. Sales increased 11% and earnings ballooned 46% despite a rise in the cost of raw materials. Lighting sales increased 13% while chemicals increased 4%. New products caught on nicely, price increases stuck and Home Depot increased its orders. Acuity generated about $40 million in free cash during the quarter, analysts say. It used the cash to buy back two million shares, bringing to four million the number of shares repurchased so far this year. (Option exercises brought about by the rising stock price have added 2.9 million shares at the same time.)

Acuity didn't offer any earnings guidance, noting only that it expects to "meet or exceed" its long-term targets for margin expansion, earnings growth and free cash flow this year. One of the company's long-term goals is to reach an operating margin of 10%. Third-quarter operating margin increased 1.6 percentage points to 8.7%.

Based on freshly increased earnings estimates, Acuity shares might be too cheap. They can be had now for 19 times forecasted 2006 earnings. The company is expected to boost its earnings by 52% this year, 21% next year and 15%, on average, over the next five years. Divide the price/earnings ratio by the long-term earnings growth estimate and you get a PEG ratio of 1.27. That's a discount of around 15% to the broad market, and it assumes Acuity merely meets its earnings estimates. Last quarter it topped them by 12%.