Orion Energy Systems
Date: 01/06/2021
Price: $10.28
Shares outstanding: 30,715,810
Market Cap: $315mm
The energy transition this country has started will be very interesting to watch. While domestic oil and gas has never been as abundant as it is now, federal and state governments are investing heavily in renewable energy (solar & wind) to decrease the amount of carbon released into the atmosphere. At the same time, companies are trying to become more energy efficient to reduces costs and decrease their carbon footprint. One simple but overlooked action companies can take is by replacing their current lighting sources (filament bulbs, florescent lights) with solid-state lighting sources, such as LED lights, and installing energy saving instruments (motion sensors, timers, smart building software). Based on a report by the Department of Energy (DOE), it is estimated that LED lights have a current market share of 44% and 29% in commercial and industrial buildings, respectively. This includes general purpose, directional, decorative, linear, low/high bay, and other types of lighting fixtures. This report will focus on linear and low/high bay lighting fixtures as that is what OESX generally installs for its clients. The penetration of lighting control systems (dimmers, sensors, software) is much lower at 34% and 7% for commercial and industrial buildings.
OESX
Orion Energy Systems, Inc. designs, manufactures, and installs lighting solutions for manufacturing facilities, warehouse, and big box retailers. The main service the company provides is upgrading existing the lighting systems of existing facilities. The company when public in 2007 and was focused on installing florescent lighting systems for its customers. At the time, florescent lights were the most energy efficient lighting source for low bay (10-12 ft. ceilings) and high bay (>12 ft. ceilings) structures. The lighting industry started going through a transition around 2013 when LED lights became cheaper to manufacture and were more energy efficient than florescent lights[1]. Besides greater efficiency, fluorescent bulbs are made with mercury, making disposal and recycling much more difficult than LED lights. LED lights last five to ten years while fluorescent lights tend to have a lifespan of three to five years.
OESX has relationships with 40% of the Fortune 500 companies. The picture below gives you an idea of the customers OESX has worked with.
Source: OESX Slide Deck November 2020
The company a three sales channels it utilizes, a dedicated sales team to national accounts, 3rd party sales agents, and energy service companies (ESCOs). The current CEO, Michael Asltschaefl, took over in 2017 and made it his focus to cut costs, improve margins, and grow the company’s 3rd party sales agent channel. Mr. Asltschaefl has been successful at cutting costs. General and administrative expenses have declined from $14.8mm in FY 2017 to $11.2mm in FY 2020. Sales and marketing costs have declined from $12.8mm to $11.1mm over the same period. While his efforts have not yet resulted in higher gross margins, the revenue growth the company has experienced demonstrates the scalability of the company’s operating costs.
Chart 1
Chart 2
Chart 3
Expanding the agent sales channel required bringing on new sale agent relationships and educating them on OESX’s suite of services and products. The benefits of a having a sales agent is it introduces your products to larger audience at a more affordable price then what could be accomplished by a dedicated sales team. The drawbacks are that these sales agents also sell the competitors’ products, and the sales agents take a commission on any sales. Commissions would be paid whether a 3rd party makes the sale or the company’s dedicated sales team does, but a sale completed by a third party hinders a company’s ability to develop a relationship with the client. OESX has relationships with 50 different sales agents. The performance from this sales channel has been inconsistent over the years. (See chart 5 below)
The national accounts sales channel has been the driver of the company’s recent success and drove much of its success in the past. This is the sales channel that allows the company’s competitive advantages (customizable and turnkey solution provider) to really shine. Historically, growth from this sales channel was driven by the company’s relationship with two car manufactures (Ford and Toyota). Recently, the sales channel has signed contracts with a global online retailer, a global logistics company, and several larger retailers. The company has signed contracts for $200mm of sales since April 2019. To put that in perspective, the company did $196mm in revenue in the three years prior to April 2019.
Chart 4
Chart 5
OES represents national sales channel, OSD represents 3rd party sales agent channel, and USM represents ESCO sales channel
This recent success seems to be driven by two factors. First, success begets more success. As OESX is able to demonstrate its ability to execute, more companies feel comfortable hiring them for lighting systems upgrades. There is also a larger, macro tailwind pushing the company forward. Energy efficiency and reducing carbon footprint has become a top priority for many companies. One of the easiest ways to do this, especially in the commercial and industrial sector, is to upgrade the lighting system. OESX’s lighting systems can save customers up to 50% in energy costs by replacing old lighting systems. The payback period for this investment by the customer is one to four years. This does not include the various government and utility incentives that a client might be eligible for. OESX will help its clients apply for various energy saving incentives so the client gets the greatest return possible on its investment. Every buildout is going to be different depending on the needs of the customer, but recently announced contracts generate ~$140,000 of revenue per facility.
Example of a savings summary for a client
Source: OESX brochure
IoT and Sensors
Besides greater energy efficiency and longer life, the other advantage LED lights have over fluorescent lights is that because LEDs are controlled by semiconductors, its easier to attach sensors and connect them to a network. There are two types of sensors. Basic sensors consist of motion detection and dimmers. These do not require 3rd party software to operate and are generally used to increase energy savings. Advance sensors can track the movement of assets, temperature, and create heat mapping. These require 3rd party software to run and create meaningful data. OSEX has designed their LED lights to be plug-and-play and are technology agnostic. Most brands and technology can be added to their lights either at the time of installation or later. OESX does not build software or the advance sensors.
Total Addressable Market (TAM)
Management has refused to discuss the company’s market opportunity other than to say it is very large. This is not an easy puzzle to figure out. I am going to approach this problem in the same way you would try to calculate the number of piano tuners in Manhattan. I will start laying out my assumptions. As I stated earlier, the average cost of retrofitting a single facility is ~$140,000. I am going to use the average size of a Home Depot store as the basis for a lot of the assumptions going forward. (Note: this exercise resulted in a HUGE TAM, even after a 50% haircut. The last paragraph calculates a much more reasonable TAM).
The average Home Depot store is 105,000 sq ft. For a 20,000 square foot facility with 30-foot ceilings, it is recommended to install 36 high bay light fixtures. That means that the average home depot store has 189 high bay light fixtures.
The U.S. Department of Energy (DOE) released an update to its “Energy Savings Forecast of Solid-State Lighting in General Illumination Applications” report in December 2019. The report measures the current market share of LED lights across commercial, industrial, and residential structures. I am going to focus on linear fixtures and Low/High Bay fixtures.
The table below is a summary of the findings in the DOE study. The number of installed units is measured in millions. Each light fixture is a unit.
| 2020 | ||
| Linear Fixture | Low & High Bay | |
| (millions of units installed) | ||
| Commercial | 221 | 24 |
| Industrial | 17 | 6 |
| Residential | 53 | 0 |
| Total | 291 | 30 |
| % Penetration | ||
| Commercial | 28% | 29% |
| Industrial | 29% | 24% |
| Residential | 19% | 0 |
| (millions of units opportunity) | ||
| Commercial | 789 | 83 |
| Industrial | 59 | 25 |
| Residential | 279 | — |
As you can see the there is a massive market opportunity. The number of installed units are probably lower than what is stated above because COVID delayed installations that were expected to occur in 2020.
The next table shows the TAM for each sector (commercial bay, industrial bay, commercial linear, and industrial linear). The number of lights is pulled from the table above. The number of stores (measure of how many stores still need to be retrofitted to LED lights) is calculated by dividing the number of lights, divided by 189 (the number light fixtures in an average Home Depot store). The $ value is calculated by multiplying the number of stores by $140,00 (average cost to retrofit a single store). The calculated TAM based on those assumptions is over $700 billion. To provide some room for error, I cut the calculated TAM in half (which I believe is probably closer to the real market opportunity).
| Avg light units per Home Depot Store | 189 | |
| Cost per facility | $140,000 | |
| Remaining Buildout | Commercial Low & High Bay | |
| Number of lights | 82,758,621 | |
| Number of stores | 437,876 | |
| Value | $61,302,681,992 | |
| Remaining Buildout | Industrial Low & High Bay | |
| Number of lights | 25,000,000 | |
| Number of stores | 132,275 | |
| Value | $18,518,518,519 | |
| Remaining Buildout | Commercial Linear | |
| Number of lights | 789,285,714 | |
| Number of stores | 4,176,115 | |
| Value | $584,656,084,656 | |
| Remaining Buildout | Industrial Linear | |
| Number of lights | 58,620,690 | |
| Number of stores | 310,162 | |
| Value | $43,422,733,078 | |
| Value (Total) | $707,900,018,245 | |
| 50% Cut | $353,950,009,122 |
The DOE’s report assumes that by 2035, linear and high/low bay LED light fixtures will have 90% market share. This means that the TAM for 2035 is $319 billion. This TAM seems very large, so I want to try to find more data that will help me figure out the TAM.
According to Grand View Research, LED lights will grow from a $52 billion market in 2020 to a $127 billion dollar market in 2027 (13.4% CAGR). Growing from $127 billion to $319 billion in 2035 requires a 12% CAGR. If we look at the DOE report, it estimates that the CAGR for LED lights over that period is only 4%. At a 4% CAGR from ’27 to ’35 results in a market size of $167 billion.
Services
Service revenue is generated by site assessment, engineering design, and energy saving analysis services provided by the company. Management would eventually like services to constitute 20% of overall revenue (25% of revenue in FY 2020).
Thanks to the success of SaaS in 2020, analysts have been asking the management team if there are any opportunities to introduce a recurring revenue model into their business. The only opportunities right now are partnering with the hardware and software companies that develop the advance sensors (asset tracking, temperature tracking, heat mapping). OESX could set up a partnership that entitles the company to a small percentage of the monthly revenues, but this is not happening right now. Maintenance is also a possibility but because of the lifespan of the lights and the early stage of the transformation from florescent to LED, basic maintenance the blub replacement will not occur for a few years.
Valuation
OESX certainly seems to have hit an inflection point. The company’s national account sales channel has captured valuable wins over the last 18 months and will likely lead to more contracts. The company also has a strong macro tailwind with companies looking to decrease carbon footprint. My valuation assumptions are:
Revenue Growth 13% annual growth 2021-2027, 4% annual growth 2028-2035
Operating Margin: 9% in 2021, increasing by 1% annually until topping out at 15% in 2027 and maintaining for rest of model
Share dilution: 2% annually
Using a 10% discount rate and 2% perpetuity rate, results in a $44 price target and 10% IRR.
I acknowledge that the company seems to have a competitive advantage in its ability to provide a turnkey solution to clients. It also has an advantage over other competitors that source LEDs from foreign factories due to OESX’s Wisconsin manufacturing facility. The company also has the most efficient product on the market that produces 214 lumens per watt and charges a much lower installation fee (see image below). But I have a difficult time underwriting a 10% IRR investment in this company and being comfortable with the investment. The TAM and macro tail wind are clear benefits for the company, but it has only executive effectively for one year. I am also puzzled by the CEO’s commitment to growing the 3rd party sales agent channel when it has been the national accounts sales channel that has been growing sales and is most likely to build a sustainable relationship with tier one customers (Home Depot, Amazon, etcetera). Low-cost provider, superior product, and growing customer base are all factors that usually scream amazing investment opportunity. But I am going to wait to see if this company can continue to execute. And maybe by the time the company can sustainably execute at a high level the stock will be too expensive. I will just have to live with that.
Disclosure: No position in OESX
[1] Fluorescent tube lights produce 50-100 watts per lumen, LED lights produce at least 130 lumens per watt. OESX produces an LED blub that produces an industry leading 214 lumens per watt.