Eco Investor November 2015

Core Securities

Can Beacon Lighting Sustain its High Growth Rate?

Simon Turner
Principal
Rising Star Research

Beacon Lighting is Australia's leading lighting retailer with 78 company-owned stores and 13 franchised stores around the country. The company is focused upon the middle to upper residential market segments with 90 per cent of its products designed, manufactured under licence and distributed in-house. The company has grown quickly in recent years largely driven by the rapid new store opening program (the store network has almost doubled over the past nine years). This high growth rate continued during 2014/15 with Beacon Lighting reporting 19.3 per cent revenue growth and 36.4 per cent EBITDA growth.

Interestingly, the underlying Australian lighting market has been relatively flat in recent years. IBISWorld estimates that the underlying market has been growing at 0.3 per cent per annum over the past five years reflecting relatively slow disposable income growth during this period. In this context Beacon Lighting is obviously gaining significant market share and is opening far more new stores than competitors.

After such a high growth phase for the business it seems appropriate to question whether these growth rates are likely to continue looking forward. We will discuss each of Beacon Lighting's seven main revenue growth drivers in this light:

1. New store rollout - Beacon Lighting is aiming to open six new stores per annum in the foreseeable future. According to recent independent analysis, the company still has ample expansion room in the Australian market at this stage. Beacon Lighting can certainly afford to open new stores at this rate as the company's gearing is low at just 13.3 per cent. The only uncertainty with this new store expansion plan lies in accessing the right properties in the right locations where there is minimal risk of cannibalisation of existing store sales. We believe it is likely that the company will meet its six new store openings per annum target over the next two to three years but longer term we expect finding the right properties will become a greater challenge. At this stage six new store openings are likely to add around 5 per cent to sales in their first year of operations and more thereafter. We believe it is fair to assume 5 per cent per annum growth from new store openings.

2. Optimising store portfolio and operations - Beacon Lighting has a solid track record of driving revenue growth through store refurbishments and expansions which bodes well for further improvements looking forward. The company has also recently introduced (September) the JustEnough forecasting and replenishing system to improve inventory management across its store network. We believe all these measures should add around 1 per cent to sales per annum.

3. New products and ranges - Beacon Lighting has an excellent track record of new product releases and has already released 132 new products in the first three months of this financial year. The company is particularly targeting a stronger product portfolio for the trade market segment which is growing solidly. Given the company's track record on this front we would expect new product releases to add in the order of 1 to 2 per cent per annum to sales. This is obviously pure market share growth and is indicative of a proactive management team.

4. Growing online sales - Beacon Lighting's online sales are growing quickly and should continue to do so looking forward. During 2014/15, online sales grew an impressive 32 per cent. The company does not disclose the percentage of sales coming from online but we guess it is currently around 15 per cent. Continued growth in online sales is likely to drive in the order of 2-3 per cent per annum sales growth.

5. Technology in lighting - Demand for energy efficient lighting is driving demand for the best LED lighting products as well as further innovation in LED lighting technology. We see this as an exciting long term revenue growth driver for the company. At this stage Beacon Lighting's focus is on developing the right energy efficient products to meet future demand. We would be cautious to assume too much from this growth driver in the short term.

6. Acquisitions - Beacon Lighting acquired the Essendon and Watergardens franchised stores in September which should add around 1 per cent to group sales. Further acquisitions of franchise stores and other businesses are likely longer term but remain unpredictable. We would not assume any more acquisitions are completed in the short term but we would highlight that the company has a very strong balance sheet for as and when opportunities arise.

7. Emerging businesses - Beacon Lighting has also invested in a number of new emerging business areas: the GE distribution and IP licensing agreement, Beacon Solar, and Beacon International. These business areas remain very small at this stage but present interesting long term potential. We would not assume these businesses contribute in a meaningful way for the next two to three years.

We believe the combination of these seven growth drivers will drive revenue growth in the order of 10-12 per cent per annum in the coming years assuming market conditions remain relatively unchanged. This is obviously well below the 19 per cent revenue growth the company reported in 2014/15 but this remains a very high revenue growth rate for a retailer operating in flat and competitive markets. By most investors' standards a company achieving 10-12 per cent per annum revenue growth is clearly categorised as a high growth stock.


Beacon Lighting’s Store Expansion.

And in terms of the margin outlook for the business, we believe margins should continue trending upwards if the company achieves 10-12 per cent per annum revenue growth. Beacon Lighting's gross margin is likely to remain roughly static at 64-65 per cent whilst the business offers excellent operational leverage through the company's tight management of operating expenses and ongoing efficiency gains. During 2014/15, the company's operating margin increased from 12 to 14 per cent driven by a fall in operating expenses as a percentage of sales from 54.6 per cent to 51.6 per cent. We would expect to see this operational leverage continuing to work in the company's favour looking forward. If past performance is a guide, 10-12 per cent per annum revenue growth should translate into around a 1 per cent per annum operating margin improvement.

Beacon Lighting's outlook remains bright in our opinion (no pun intended!). We believe Beacon Lighting is well placed to continue growing at a high rate, albeit not at quite as high a growth rate as was reported in 2014/15. And we believe margins should continue to improve. The main risk to our analysis is a dramatic weakening in the Australian economy which would flow through to all consumer cyclical sectors including lighting.

 

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