ALSN - Allison Transmission: Attractive Valuation With Possible Path To Continuously Beating Estimates

2023-05-14 23:41:45 ET

Summary

• 1Q23 revenue, driven by successful pricing strategies, exceeded expectations, and its EBITDA margin was stronger than anticipated.
• Allison Transmission increased its guidance for FY23, indicating continued momentum and margin expansion.
• Valuation is attractive at 7.2x forward earnings which is near its all-time low.

Summary

Allison Transmission Holdings ( ALSN ) is a company that produces fully automatic transmissions for medium and heavy-duty commercial vehicles. The business continues to outperform expectations, with 1Q23 results exceeding expectations yet again, and guidance was raised across the board. I'd like to point out that margins improved more than I expected, owing to pricing. Furthermore, I am especially encouraged by the qualitative comments that fueled the confidence. A combination of favorable price movements and robust demand from customers in the final market has management optimistic about 2023's guidance. While ALSN continues to face the risk of alternative drivetrain adoption, I believe the risk is far in the future and is unlikely to surface as a significant impact in ALSN financials. Furthermore, at 7.2x forward earnings today, the stock is trading near an all-time low, providing investors with a margin of safety from a valuation standpoint. Overall, I would recommend a buy rating.

1Q23 results

ALSN's 1Q23 results were much better than the market was expecting. The company's quarterly revenue of $741 million was higher than the expected $721 million. This can be attributed primarily to higher pricing strategies implemented by the company. Furthermore, ALSN demonstrated a stronger-than-anticipated EBITDA margin for the first quarter. This notable performance was primarily driven by a higher gross profit, which was also influenced by the successful implementation of price increases across various product lines. The continued demand for medium duty and class 8 vocational trucks helped propel ALSN's NAFTA On-Highway sales to $352 million, a figure that represents robust growth. Implementing price hikes also played a role in driving this result. The NAFTA Off-Highway market, meanwhile, brought in $24 million in revenue. The energy industry saw a decrease in demand, but overall international sales reached $131 million. Last but not least, the Parts & Support Equipment division brought in $183 million thanks to the stellar showing of global service parts and support equipment and successful price increases.

Raised full year guidance

After a successful first quarter and optimistic outlook for the company's end markets, ALSN increased its guidance for FY23. The guidance assumes $2.95 billion in revenue, $1.05 billion in adjusted EBITDA, and $535 million in free cash flow at the midpoint. This meant that margin expansion would continue. Assuming a midpoint adjustment to EBITDA of 35.6% for FY23, this would be a 90 bps increase over the prior year. This, in my opinion, is a direct result of successful pricing and increased sales volumes that have more than counteracted inflationary pressures. Also, this guidance shows that the business continues to have very strong momentum in the FY23 and possibly FY24, which could drive short-term momentum narrative around the stock.

Growth runway

Management has highlighted numerous opportunities and recent activities across its segments, indicating a promising growth trajectory for the company. Notably, one particularly interesting opportunity mentioned is the Chinese wide body mining dump growth initiative. ALSN has demonstrated exceptional success in capturing a significant market share in this initiative, achieving over 10% share in just 18 months. This accomplishment speaks volumes about ALSN's market position and its strong execution capabilities. Although the market size may not be enormous, it still presents a TAM with an annual revenue potential of $100 million. Additionally, ALSN's management has identified another growth opportunity in the form of the SANY 96-ton wide body mining truck in India. Currently, this market is in its early stages, offering significant growth potential. I believe with ALSN's scale and market position, it is well-positioned to continue exploring and capitalizing on new growth markets worldwide. In addition, its strong market presence enables them to attract opportunities and deal flow more easily compared to smaller, less established players in the industry. In addition to pursuing new growth opportunities, ALSN has also demonstrated its ability to retain and grow its existing customer base. A notable example mentioned during the conference call is ALSN being awarded a renewal contract by the US Army in February to serve as the propulsion supplier for JLTV A2. ALSN has been the supplier for JLTV A1 since 2015. This development is highly encouraging as it signifies a level of customer loyalty and stickiness. As long as ALSN continues to provide reliable products and avoids significant product failures, customer retention is expected to remain high. The trust established with customers, coupled with the crucial nature of ALSN's products, emphasizes the importance of product quality alongside cost considerations.

Valuation

I believe the fear of ALSN losing share to alternative drivetrains might have been over-worried in the market, as such valuation have been pushed down to the current levels of 7.2x PE. I believe that if ALSN continues to meet or beat its FY23 guidance, which it should be able to do given the pricing momentum and flattening/stabilizing cost base as inflation fades, there is a chance that ALSN will provide stronger-than-expected FY24 guidance as well. If it does, we may see a reversion of multiples to the mean level of 11x PE. I'd like to point out that ALSN has a history of repurchasing its own stock and paying down debt, both of which are very shareholder-friendly. The cheaper the valuation today, the more accretive the buybacks are.

While the risk of alternative drivetrain risk is appealing, it is unlikely to materialize in the near term. Simply put, I do not expect it to have a significant impact on ALSN's financials. Meanwhile, ALSN could continue to outperform expectations by raising prices (as it did in 1Q23). This is very encouraging from a technical standpoint because it shows that ALSN is consistently outperforming estimates.

Conclusion

In summary, ALSN has consistently outperformed expectations, with strong 1Q23 results and raised guidance for FY23. Importantly, 1Q23 and FY23 guidance showed that ALSN can continue to sustain pricing power in the short-term while cost base stabilizes, thereby driving margin expansion. Despite concerns about alternative drivetrain competition, I believe the risk is unlikely to impact ALSN's financials in the short term. With a favorable valuation today and a possible path for ALSN to continue beating estimates and raising guidance, I recommend a buy rating.

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