The Company
Allison Transmission Holdings, Inc. (NYSE:ALSN) is a $5.3-billion market cap company based in Indianapolis, Indiana, that designs and manufactures vehicle propulsion solutions, including automatic transmissions and electric systems for various applications. They offer transmissions for a wide range of applications, including trucks, buses, construction, and defense vehicles. These products are marketed under the Allison Transmission and ReTran brand names. Additionally, the company sells replacement parts, support equipment, and provides engineering services to original equipment manufacturers, distributors, and the U.S. government through a network of around 1,600 independent distributor and dealer locations.
While most of their revenue (74%) comes from North America, they also have a global presence, serving customers in Asia, Europe, South America, and Africa through a network of independent distributors and dealers.
The company operates in a single segment, but provide revenue breakdown by end-markets to better reflect the impact of economic factors on their cash flows.
In the second quarter, Allison Transmission Holdings, Inc. reported robust financial and operating performance across almost all of its end markets.
Total net sales increased by 18% YoY, reaching a quarterly record of $783 million, contributing to a record 1H revenue of >$1.5 billion. Despite challenges in the operating environment, Allison managed to increase its gross margin by 190 basis points YoY and achieved a 52% YoY growth in EPS to $1.92, surpassing the consensus figures by a heavy margin:
They have also been actively investing in their defense end market, anticipating $100 million of incremental annual revenue in the coming years. I wrote in my recent article on ICF International (ICFI) that I believe U.S. defense spending will most likely only increase in the coming years, so ALSN’s expansion in this end market seems absolutely realistic to me personally. The company is involved in various U.S. Department of Defense programs, including the M10 Booker Light tank and the M88A3 armored recovery vehicle, offering additional revenue opportunities. Furthermore, the eGen Force electric hybrid propulsion system is set to contribute to long-term growth in the defense market as modernization programs gain importance.
Allison’s international growth is also expected to be robust, being delivered through partnerships with global defense OEMs, such as Turkey, South Korea, Egypt, Australia, Norway, and Poland. Additionally, new product developments like the 3040 MX transmission are poised to drive international growth, with applications in India, Poland, and other European programs, the management noted during the latest earnings call.
In addition, the company sees development opportunities in the hydrogen combustion engine market, which is estimated to be worth $35 billion in 2030 and is expected to reach ~$89 billion by 2040, at a CAGR of 9.78% during the projection period. ALSN positively looks at the regulatory changes in Europe and the potential shift in the U.S. toward hydrogen combustion, as hydrogen-powered vehicles would use conventional transmissions, aligning with Allison’s expertise.
Furthermore, over the past few quarters, it is evident how the company’s robust operational performance has significantly enhanced its liquidity and leverage positions. The current ratio is approaching its highest point in the last decade, and the debt-to-equity ratio has returned to pre-COVID levels, standing at less than 0.5:
Another metric of financial improvement after COVID times is debt coverage through cash flow from operations – this metric of ALSN is now over 0.3 on a TTM basis, which means that the company is able to cover more than 30% of its total debt through cash flow from operations alone, which is quite a lot.
Allison has raised its FY2023 guidance after reporting for Q2, with anticipated net sales of $2.96-3.04 billion, reflecting strong demand and growth initiatives. The company also expects solid net income, adjusted EBITDA, cash flow, and free cash flow in 2023.
I like the company’s performance and growth, and its addressable markets look promising in my opinion. But how attractive is the stock, really, considering it’s up >46% YTD?
The Valuation
According to Seeking Alpha’s Quant System, ALSN has a fairly strong Valuation profile, rated “B-” with key metrics 30-50% below the sector medians.
ALSN looks very cheap compared to its peers – Eaton Corporation (ETN), the closest in operational terms, trades at an EV/EBITDA 2.9 times that of ALSN, and the company ranks last in terms of P/E ratios:
At the same time, the company cannot be said to be lagging behind its peers in its projected growth: The forwarding company’s growth figures show the opposite:
According to my calculations, ALSN should be worth $6.5 billion after deducting net debt, assuming a median EBITDA of a projected $1.05-1.11 billion and an EV/EBITDA of 8x, which I think is very fair. This results in an undervaluation of 22% compared to the current market capitalization.
The Bottom Line
Surely, investing in ALSN stock carries various risks everyone should be aware of. For example, the industry risk is a concern due to the cyclical nature of the commercial vehicle sector, where economic downturns can reduce demand, negatively affecting the company’s sales and profits. Competition risk is present as rivals like Eaton Corporation, Dana Incorporated (DAN), and others offer similar components for commercial vehicles, and losing market share to these competitors could impact ALSN. Technology risk emerges from the industry’s rapid technological advancements, which may challenge ALSN’s market position if it fails to keep up. Economic risk is linked to general economic downturns affecting commercial vehicle demand. Geopolitical events and global operations introduce geopolitical risk, including trade wars and currency fluctuations.
Despite these risks, however, ALSN appears to be a fairly solid player in its industry, with improving financials and strong tailwinds from end markets that are likely to continue to positively impact the company for the foreseeable future. In addition, the 22% undervaluation I’ve identified provides investors with some margin of safety.
Therefore, I rate ALSN stock as a “Buy”.
Thanks for reading!