ALSN - Allison Transmission Holdings: High Chance That The Business Could Beat FY23 Guidance

2023-08-04 02:50:03 ET

Summary

• Allison Transmission Holdings reported strong performance in 2Q23, with increases in revenue, gross profit, and adjusted EBITDA.
• The company experienced growth in sales across various sectors, including medium-duty and Class 8 vocational trucks, hydraulic fracturing applications, and defense vehicles.
• ALSN's guidance for FY23 reflects conservatism and is easily beatable, with the potential for further growth due to strong demand and favorable pricing.

Summary

Allison Transmission Holdings ( ALSN ) is a company that produces fully automatic transmissions for medium- and heavy-duty commercial vehicles. Readers may find my previous coverage via this link. My previous rating was a buy (stock is up 24% since then), as I believed ALSN would benefit from favorable price movements and robust demand from customers in the end market. I am reiterating my buy rating as I expect ALSN to at least meet its FY23 guidance with a high chance of beating it given the favorable pricing environment and strong underlying demand profile.

Financials/Valuation

In 2Q23, ALSN reported $783 million in revenue, $381 million in gross profit, $288 million in adjusted EBITDA, and an EBITDA margin of 36.8%. When compared to the previous year, this is a significant increase of 260bps. Management has also increased their guidance for sales and adj EBITDA for FY23, with the midpoint showing an 800bps increase in sales and a $30 million increase in adjusted EBITDA.

Strong performance in medium-duty and Class 8 vocational trucks, as well as favorable pricing, drove 17% growth in North American On-Highway sales to $397 million. The increased demand for hydraulic fracturing applications contributed significantly to the 25% increase in North American Off-Highway sales to $25 million. Defense revenue increased by 14% annually to $33 million, driven largely by increased demand for use in wheeled vehicle applications. Demand in Europe and Asia was particularly strong, contributing to a 17% increase in On-Highway sales to $123 million outside of North America. Sales of Off-Highway vehicles outside of North America fell by 25% to $24 million in that time period; this drop was caused by weaker demand in the energy sector, which was only partially offset by gains in the mining and construction industries. As a result of increased demand for service parts and support equipment, sales of service and parts increased by 31%, reaching $181 million.

Using the same valuation philosophy I used previously, I believe the fear of ALSN losing share to alternative drivetrains remains, as its valuation remains at a low level of 8.4x forward PE relative to its own valuation history. Given my increased positivity that ALSN would be able to meet (and likely beat) its FY 23 consensus, I see a high chance for the market to forget about the risk with alternative drivetrains and bump the valuation up as they see earnings growth momentum. If this does, we will likely see a reversion of multiples to the mean level of 11x PE. Attaching 11x PE to consensus FY23 EPS estimates puts the stock at $75, which is a 27% upside.

Comments

I am positive about management's raising guidance for FY23. Not only because it helps with modeling for FY23 numbers. The underlying assumptions are the key reasons for my positivity. In 2Q, ALSN realized around $45 million of price benefit (representing 6.7 points of growth vs. 2Q22) and now expects FY23 pricing benefit to be at 500bps, representing a figure of $138 million. If we do the math, removing the benefits seen in 1H23 implies a 250bps pricing benefit in 2H23. All of these point to one conclusion, and that is that ALSN is able to enjoy very favorable pricing action (as I noted previously).

I believe that ALSN's gross margin will grow in the coming quarter/year as a result of the company's increased efficiency and the favorable pricing environment. With an eye toward 2024, management is currently estimating the rate of inflation in costs and concentrating on enhancing operational efficiencies as the supply chain undergoes further development. They hope to cut costs by decreasing the need for expedited shipping and staff overtime, and by increasing output. Management has stated that there is an opportunity to increase prices due to rising costs of vehicles, labor, repairs, and maintenance supplies.

As such, I believe FY23 guidance reflects conservatism and remains easily beatable. Management is guiding for a revenue of $3 billion at the mid-point, representing 8.3% growth, of which 500bps is effectively in the bag as management literally raised their outlook 7+ months into the year. Hence, ALSN would need another 330bps of growth to meet or beat guidance. I think this is easily attainable because the demand environment is still strong for medium-duty trucks as OEMs satisfy pent-up demand from aging fleets, the rental market remains strong, and the vocational sector continues to reap the benefits of growth in infrastructure spending. Also, notably, the current inflationary pressures favor ALSN's value-based pricing and share gains because of the company's product offerings that improve vehicles' fuel efficiency.

Risk & conclusion

ALSN has shown strong performance in its second quarter of 2023, with strong revenue growth and favorable pricing. The management's guidance for FY23 indicates conservatism, leaving room for ALSN to surpass expectations. Considering the potential for beating FY23 guidance and the possibility of the market reevaluating ALSN's valuation, the stock presents an attractive upside potential.

For further details see: