2023-07-24 18:38:52 ET
Summary
- I believe Assa Abloy is a solid investment with excellent fundamental safeties and a potential upside at a good valuation, despite its high valuation and low dividend yield.
- The company has reported strong sales growth, record EBIT and margin improvements, and has an active M&A policy, with 8 M&As signed in the first half of the year, representing sales additions of almost 18B SEK.
- Despite its high valuation, the company is expected to average growth rates of 8-9.5%.
Dear readers/followers,
This won't be the first time that I review or look at Assa Abloy ( ASAZF ), a small stake in both my private and corporate portfolio. The company is what I would consider an almost timeless investment in access, locks, and ancillary segments and industries. If you "know" what you're getting with this company, then it may be a profitable venture for you to invest in - but expectation management is key for Assa Abloy, as it does come with a few caveats.
The first of these, and it's always good to mention this from the get-go, is the lack of a "rags to riches" story that this company offers. When I invest, I look for one of two things. Safe, timeless companies with a high yield that offer income, albeit not much capital appreciation, or investments typically with a higher risk/reward that have the potential for 100-300% 3-5 year RoR, but that still have fundamental safety. I don't often go for companies with very high valuations, very low yields, and not much potential for growth or massive RoR.
Still, this is one such company and one such exception.
Revisiting the upside in Assa Abloy
Now, as I said, Assa Abloy won't make you rich - at least not in anything resembling the short term. The company which trades under the native symbol ASSA-B is an above-average quality business service/industrial company with profitability margins that on average are above the median in the industry. The company, for instance, manages a double-digit net margin, an RoE above 15%, and an ROIC of almost 10%.
The first thing I look at in a company is always how they make their money, and how "good" they are at doing this. To me, there is almost no excuse for being an unprofitable or inefficient participant in the market. Even "new" companies don't have this excuse to me. It's fine for companies to be new and unprofitable - I just won't invest in them, because they don't fit my overall targets or investment profile.
So when I see a profile like the one above, with a very attractive mix (and also knowing what each of the segments, like Entrance Systems and global tech, entails), then I know that what I'm getting is, as far as reported results go, a very streamlined company. COGS is low for a company that manufactures things - at the 60% level, there could be a 100-200 bps increase and it would still be within a comfortable margin. 23.9% OpEx is excellent, especially considering that sub-20% SG&A for a company that actively sells and markets its products through a variety of means.
We have the reporting of the 2Q23 period as of a week ago - and we can see continued organic growth in sales, in both global tech, and Americas, with stable development in the remainder of the segments.
Despite massive inflationary headwinds across the world, the company is seeing very good (record-level) EBIT and strong margin improvements, almost against the grain in the context of my expectations. With record operating cash flow, the story and why Assa Abloy is performing at the level we're currently seeing, is very clear.
The specifics are below.
Some contextual highlights include project wins for 5,000 pedestrian doors and 500 trailer restraints from a major retailer in North America, as well as multiple mobile credential wins in various segments. This includes a leading cruise line, and physical access control development for a major player in finance, including 6,000 HID signo readers with employee badges in Apple Wallet Capability. The company also launched its first facial recognition lock in India, IOT-enabled dock levers, and other products, which are winning continued design and engineering awards across the globe (Source: Assa Abloy, 2Q23 Earnings Call).
Sales growth has gone down of course, in the context of massive periods such as early 2021, but is still at good levels, and the company now has annualized sales of over 130B SEK at an operating margin (EBIT margin) of 16.2% on a rolling 12-month ex-dividend basis.
This is very good profitability for a company in this industry.
The company continues its active M&A policy, with 4 M&A's signed in 2Q, 8 in 1H, and representing sales additions of almost 18B SEK, including companies like GuardRFID, Connexient, Alexander & Wilks, Iberon, and others.
Margins in the Americas have been "shining" in the past few quarters. The segment has an operating margin going above 24% with a very good mix, very strong operating leverage, low material costs (compared to EU), low energy costs, strong pricing, and good efficiencies. It could have been even higher, if not for ongoing M&As.
However, this rocket-like margin is then dragged down by areas like APAC, which have operating margins of 7.8% due to sales declines. It's important to realize that in context, this margin is actually very good. Less than 3 quarters ago and in YoY, it was at 1.9% - so the improvement is there. It'll just take a long time for the margins to shine at the levels of NA and other areas.
The driver for this strong sales development wasn't as much volume, as it was the price. The company's price increases have flowed through very efficiently and with seemingly little customer pushback. As material costs lower, I believe we're going to see further operating leverage to the effect we're seeing now.
HHI was a strong addition to Assa Abloy. For the 6M period in 2023, the company had very strong sales and overall good EBIT margins. There's a tax benefit that's relevant for the company, and Assa Abloy has effectively lowered its exposure to the somewhat cyclical and lower-margin area of residential to around 33%, from where it was closer to 50%.
Assa Abloy has, for as long as I've followed and looked at the company, been a very strong capital allocator and executor when it comes to M&As.
My worries about investing in Assa Abloy are extremely low. The company, like any other business, is increasing its cost control and spending where it can. This includes a reduction in spending for things like marketing, and external services, limiting employee OT/working hours, solving redundancies, reducing staff by 600 people (though mainly in EMEIA and Entrance Systems in Europe), and severely limiting travel expenses. This is expected to bring about total 2023 savings of around 800M SEK, or around $80M at constant currency levels.
As a result of HHI, the company's leverage is up significantly. That's perhaps the one thing to look at here - but as a counterpoint, the company is still A-rated, it's still nowhere near a high risk level despite that debt/equity ratio where I would consider it becoming to any degree uninvestable.
Where the company is lacking is in regards to the dividend - which is below 2% at this time - and the valuation. The valuation is, and has remained high for many many years (though it's now at a point where I think investment is still possible), and I don't foresee the growth rate "exploding" here, but rather sticking to those high single digits.
None of this is bad - as long as your expectations are moderated. Then Assa Abloy has a place in your portfolio.
Assa Abloy - the valuation is compelling if you allow for a premium
The valuation for Assa Abloy is, without a doubt, at a high level. An industrial/building products/services company trading at 20x P/E isn't cheap no matter how you spin it, even with an A-credit rating.
But in this case, the valuation is warranted in my view.
The company is expected to average growth rates of 8-9.5% for the next 3 years in terms of adjusted EPS. Much of that profit will go to reducing debt, but the expectation is also for a significant 2023E dividend increase - more than 15%, in fact (Source: FactSet).
If this occurs, you'll see an above-2% yield for this company, which coupled with the capital appreciation upside is potentially enough for a double-digit annualized return at a P/E valuation of 20.7x.
This is a non-trivial upside for a business like this - and certainly good enough to where I say you can invest here. That's why my rating continues to be a "BUY" here. In my last article, I had a PT of 255 SEK/share. I'm sticking to this, and reviewing a potential PT increase to the 265 SEK/level to account for some of the positives I see here. The overall sentiment hasn't changed much from my previous thesis - the company is still richly valued and should be considered with care - but there is an upside to be had, and I view it as realistic.
Assa Abloy, due to its stable development and forecastability is a good target for a DCF analysis. And a conservative DCF with a 9% growth rate during the growth stage, and a terminal 3-4% growth rate estimate with a double-digit risk-free discount rate implies a fair value of 282 SEK, which gives you a margin of safety of over 11% at this price.
Street targets are actually almost at the same level. With 21 analysts covering the company, their average ranges go from 220 to 330 SEK, with a PT of 280 SEK/share, implying an 11% upside here. 9 out of 21 are at "BUY" or "Outperform" - so some conviction issues do exist. The company is a much better buy at below 220 SEK/share, but I don't think that we will easily get such an entry point given the trends that the company is currently giving us.
Analyst accuracy rating is close to 100% in this company even with a low margin of error. The only miss analysts have had here was during COVID-19, and it was hardly the only miss for a usually-stable company during that year.
For that reason, I continue to consider Assa Abloy to be one of the most solid investments you can make in terms of overall safety on the entire Swedish market. It has international appeal, it has timelessness, and it's a clear market outperformer and in many segments, a market leader.
Even at 250 SEK, there is nothing wrong with buying Assa Abloy.
Here is my current thesis for 2Q23.
Thesis
- Assa Abloy is a global, market-leading provider of solutions in access, ID, locks, and passage systems. The company is an M&A-heavy, proven capital allocator with excellent fundamental safeties and a potential upside at a good valuation. At a cheap price, it's possible to deliver significant market outperformance by investing in the company.
- However, at 250 SEK/share, valuations are still stretched and my position seems to have reached most of its potential. There is a 5-7% growth potential from here, which with efficiencies translates into an 8-12.5% annualized upside from a premium as of July of 2023 and with 2Q23 reported.
- The latest quarter was more or less just a confirmation of the bullish thesis on the company - and I continue to view the business positively.
- This is a "BUY", but a quite weak one, all things considered.
Remember, I'm all about:
- Buying undervalued - even if that undervaluation is slight and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
- If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
- If the company doesn't go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
- I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them ( italicized ).
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside that is high enough, based on earnings growth or multiple expansion/reversion.
Assa Abloy is not "cheap" here, but it still does have an upside potential - so I'll say "BUY".
For further details see:
Assa Abloy: A Long-Term Holding Worth Considering