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Allison: Global Automatic Transmission Leader Trading at a Discount

The stock market is seriously undervaluing this leading automotive systems supplier

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Praveen Chawla
Sep 26, 2021

Summary

  • Allison is an asset-light business with high returns on equity and capital.
  • The company generates solid free cash flow.
  • Allison is significantly undervalued.
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Allison Transmission Holdings Inc. (

ALSN, Financial) is a designer and manufacturer of highly engineered vehicle propulsion solutions for commercial and defense vehicles. It’s the world’s largest manufacturer of medium- and heavy-duty fully automatic transmissions. It is increasingly moving into electrified vehicle propulsion solutions.

It was previosly part of General Motors Co. (

GM, Financial) before being sold to private equity firms The Carlyle Group and Onex Corp. in a deal valued at $5.6 billion in 2007. On March 15, 2012, its initial public offering of 26.3 million shares was priced at $23 per share on the New York Stock Exchange.

With a 100-year operating history and a record of accomplishment in innovation, Allison Transmission is the global leader in the markets it serves with a premier fully automatic transmission brand and as an established supplier of fully integrated electrified propulsion systems. It has a solid financial position with an industry-leading operating margin and significant free cash flow generation. Allison has a history of returning capital to shareholders via buybacks and dividends.

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The following chart shows Allison's net sales breakdown by end market.

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Allison’s revenue, which was rising until it took a hit in 2020, is recovering and so is its income. The company is cyclical, so revenue is very much tied to the economy and truck production.

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Operating margins are healthy at over 25%. The question now is, of course, whether these margins are sustainable as the shift to electric vehicles accelerates for heavier vehicles.

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Allison started off its independent life with around $2.8 billion in long-term debt. However, it has bought back a lot of its stock over time. As the chart below shows, diluted shares have decreased from 186 million to around 109 million since 2012. This is a consistent buyback rate of 6.8% a year. In addition, the dividend yield of 2.1% is also growing. Overall, this is an excellent shareholder return.

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Following is a snapshot of Allison’s balance sheet. A couple of things standout, including its high level of long-term debt and large intangible assets. (These items are a legacy of the company’s time with private equity. Its part of private equity leveraged buyout playbook to buy undervalued assets, load the company with debt, extract equity and bring the company back into public market at an opportune time.)

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Allison's debt maturity profile is spread out, but with plenty of liquidity it's not something to worry much about. Ebitda is comfortably more than 4.5 times of interest on debt.

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Summary

Allison is currently selling at a price-earnings ratio of 9.33, which is arguably very low for a company growing sales and earnings at a double-digit rate over the last five years.

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Looking at the following chart, which shows the stock's valuation based on its median price-earnings, price-sales, price-book and price-to-operating cash flow, I think the stock price should be in the mid-$40 range. Value Line’s projections put it at a $50 per share target in 18 months and the three to five-year range in the $60 to $70 band. This is consistent with my assessment.

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Insider activity is neutral. An examination of recent insider activity suggests insider buying when the stock in the $30s and selling when in the $40s. Based on these trends, it appears to be an opportune time to buy the stock.

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The market is anticipating the coming electrification of trucks with all the hype surrounding Tesla's (

TSLA, Financial) semi-trucks, Ford's (F, Financial) F-150 Lightning, General Motors' Hummer as well as other startups like Nikola (NKLA, Financial) and Lordstown Motors (RIDE, Financial), among others. Investors are currently unsure as to what degree these new-fangled electric trucks will require gears and transmissions and, if so, whether these electric transmissions will require the intricate level of engineering associated with ICE vehicle, or if will they be simpler affairs. Some trucks, like the one from Lordstown Motors, don't even have an axle as the motors are in the hubs of the wheel. This uncertainty has beaten down Allison's stock, compressing its valuation, as expressed by the lowering of the enterprise value/Ebitda ratio. However, the thought that Allison will be left adrift in the coming electrification of the truck market is an oversimplification.

Electrification of the truck market will proceed slowly, giving Allison sufficient time to shift its product range to cater to hybrid and electric vehicles and entirely new product lines. Allison is making opportunistic tuck-in acquisitions to bolster its capability in electrification. For example, Allison Transmission acquired Vantage Power and AxleTech’s electric vehicle systems division (fleetequipmentmag.com). In fact, it's already made much progress in this regard and has introduced new systems to cater to hybrid and fully electric vehicles. About 8% of Allison's sales comes from heavy defense vehicles like main battle tanks and armoured personnel carriers, which will likely be never electrified (imagine trying to find a charging outlet on a battlefield).

Allison’s return on equity and return on invested capital is exceptionally good. Hence, absent a recession, I see no clear reason why the stock should continue to languish in the mid-$30s for long. It was trading in the high $40 range before the Covid-19 pandemic and the company's earning power is in no way impaired. I think the stock market is underestimating Allison and attributing a low multiple to earnings based on its position as an auto part supplier to the truck industry. However, I think Allison is a more of an asset-light, intellectual property-based business given it high return on equity and return on invested capital.

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Disclosures

I/we have no positions in any stocks mentioned, but may initiate a Long position in ALSN over the next 72 hours.
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