ALLE - Allegion: Providing More Security Here

2023-12-31 06:13:10 ET

Summary

• Allegion's valuation has become more attractive due to lower valuation multiples and a compelling deal for Stanley Black & Decker's security assets.
• The security products provider looks to provide a lot safer investment opportunity as well, amidst reduced earnings multiples and lower leverage.
• Despite a recent rally, Allegion's outlook is brighter with continued growth, reduced valuations, and improved leverage.

In the spring of 2022 I believed that shares of Allegion ( ALLE ) started to look more secure. Its premium valuation has compressed a bit, but shares were still trading at a premium to the market. The lower valuation multiples and a compelling deal for some of Stanley Black & Decker's ( SWK ) security assets made the investment case look a lot more compelling.

Ever since, Allegion has seen continued growth which has reduced valuations even more, as a modest premium translated into a modest discount this year, all while leverage has come down a great deal. This makes that the outlook from here onwards seems a lot brighter, although that a recent rally prohibits me from chasing the shares here.

Security Products provider

Allegion is a pure-play provider of security products and solutions. These security solutions, products and services are supplied and applied in residential and business settings.

Typical products to think of include mechanical locks, electronic locks and portable security solutions marketed under brand names like AXA, Kryptonite, Legge, Bricard and Schlage, among others. For business clients, the list of solutions provided is even greater, including monitoring solutions and ore electronic access solutions.

Pre-pandemic, Allegion generated $2.85 billion in sales in the year 2019, on which the company posted strong operating profits of $565 million, with margins coming in near 20% of sales. GAAP earnings of $402 million came in at $4.26 per share, as the business operated with a net debt load just in excess of a billion mark. Adjusted earnings of $4.89 per share worked down to a still lofty, but more reasonable 26-27 times earnings multiple.

Since the outbreak of the pandemic, shares have largely traded in a $100-$150 range, with the peak coinciding with the market rally in 2021. By April 2022, shares were down to $113 per share, trading below pre-pandemic levels.

This came after 2020 sales fell some 5% to $2.72 billion amidst the impact of the pandemic, as the company guided for a recovery in the 2021 results. That recover as revenues recovered to $2.87 billion, with adjusted earnings reported at $5.19 per share, on the back of a $618 million EBITDA number.

Despite inflationary pressures, which cast a shadow on the shares, the company guided for a high-single digit increase in 2022 sales, with adjusted earnings seen at a midpoint of $5.65 per share. With share buybacks reducing the share count to 90 million shares, Allegion commanded a $10.2 billion equity valuation at $113, or $11.2 billion enterprise valuation after factoring in a net debt load of a billion. This valued the operations at nearly 4 times sales and 22 times adjusted earnings (as reported in 2021) and 20 times adjusted earnings (based on the 2022 outlook).

This all altered a bit, as Allegion acquired Black & Decker's Access Technologies business in a $900 million deal, including manufacturing, installment and servicing of automatic doors. The $340 million revenue contribution is relatively modest, certainly as the net present value of tax synergies will reduce the purchase price to $810 million.

Net debt would double to $2 billion, with EBITDA seen around $700 million on a pro forma basis, increasing the leverage ratio towards 3 times. I concluded to become a buyer around the $100 mark, or just below that, but lost track of the shares here.

Operating Stagnant

As it turned out, shares of Allegion come under further pressure in 2022, having fallen to the $90 mark in the fall. Ever since, shares have traded in a $90-$120 range. Still trading in the $90s in October of this year, shares have seen a convincing rally to $127 at this point in time, after a rather spectacular performance in recent weeks.

The company closed on the deal with Stanley in July 2022 and early in 2023 the company started the year on a strong note as it hiked its quarterly dividend by ten percent to $0.45 per share.

In February of this year, Allegion posted 2022 results which were decent, with full year sales having risen by 14% to $3.27 billion on the back of organic growth and the purchase of the Stanley assets. Adjusted earnings per share rose about 10% to $5.99 per share, with growth held back because of higher interest expenses as the result of the additional debt incurred. Net debt has come down to $1.80 billion here, needed as adjusted EBITDA of $683 million came in touch light versus the pro forma number at the time of the deal announcement (but the deal did not contribute to all of 2022 as well).

For 2023 the company guided for a 9 to 10.5% increase in full year sales, with organic growth seen at a midpoint of 3.5%. Full year adjusted earnings are seen up to $6.40 per share, although that this outlook excludes amortization charges of around $0.40 per share.

The company hiked the full year guidance in a convincing manner following the first quarter earnings report this spring. Full year adjusted earnings are seen up to $6.65 per share, with the organic growth outlook being hiked to 6.5%. This guidance was hiked further to $6.75 per share following the release of the second quarter results over the summer, and even to $6.85 per share alongside the release of the third quarter results. Note that the acceleration in growth looks better than it is, as higher pricing more than offset a low single digit increase in volumes.

Current Valuations

With sales growth seen around 12%, Allegion is expected to post annual sales around $3.66 billion, with earnings seen around $6.85 per share. Cash flow generation made that net debt has come down to $1.65 billion, reducing leverage to less than 2 times, as adjusted EBITDA comes in around $840 million on a trailing basis.

Given this solid backdrop, shares actually looked quite compelling when shares traded around the $100 mark in recent weeks, for a multiple of 14-15 times, while leverage is much more under control. Of course, it is the big rally in recent weeks which has lifted expectations, pushing up expectations to 18-19 times earnings here.

Concluding Remarks

The truth is that I am really warming up to the shares of Allegion here as a premium multiple in the low twenties has come down to just 15 times, when shares traded around the $100 mark recently. Of course, it has been a rally in recent weeks which pushed up expectations to market multiple, but this still looks relatively compelling, given the organic growth, its track record and leverage having come down.

Given a 30% move higher in the past two months, on the back of lower interest rates, I am not tempted to chase the shares here, but recognize that shares look more attractive than they have been for a long period of time.

Given all of this, I am taking a cautious but positive outlook on the shares here, looking and hoping for a dip toward the $100 mark before initiating a position.

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