Yahoo Finance Questor: This gearbox manufacturer is set to boom – despite the EV revolution
The energy transition has created uncertainty for investors. That’s thrown up both risks and opportunities. This column believes US-listed Allison Transmission falls squarely into the latter category.
The company is a specialist maker of fully automatic gearboxes for medium- and heavy-duty commercial vehicles – such as trucks, motorhomes and school buses – military vehicles, and off-road vehicles used by the mining and fracking industries. It also makes propulsion systems for hybrid and fully-electric heavy vehicles. About three quarters of sales come from North America.
Being the leader in niche markets where it has strong customer relationships and deep expertise has proved very profitable for Allison over many years. Margins are the highest among its peers and came in at 36.5pc last year based on earnings before interest, tax, depreciation and amortisation (Ebitda). The next two closest competitors managed 33pc and 26pc.
While the business was hit hard by Covid and continues to face supply chain issues, sales and profits have recovered well from lows. Brokers are forecasting average sales growth of 6pc in each of the next two 12-month periods and 17pc for earnings per share (EPS).
Meanwhile, Allison’s business throws off cash. With relatively low investment requirements, management returns a good proportion of this money to shareholders, particularly through share buybacks. Since IPO in 2010, it has repurchased nearly two-thirds of its shares.
There is also a modest 1.3pc forecast dividend yield. The shares can be purchased through most British brokers, but UK investors must fill out the correct paperwork to minimise dividend withholding tax.
Despite Allison’s apparent attractions, the shares trade on a single-digit multiple of forecast earnings of nine.
Many of the world’s best fund managers are betting this represents a bargain.
The shares are held by a total of 23 of these investors, each of whom is among the top 3pc of over 10,000 equity managers monitored by financial publisher Citywire. The backing has resulted in Allison being awarded a top AAA Elite Companies rating by Citywire, which rates companies based on smart-money ownership.
“The market is overly concerned with the cyclical nature of the trucking market and the uptake of electric vehicles (EVs) within the trucking market,” says Sam Horn, a senior investment analyst at Polaris Capital Management working with the top-performing Boston-based team running the Pear Tree Polaris Small Cap fund.
“Switching to EVs will be a protracted process due to the total cost of ownership of the EV compared to the current cost of traditional medium- to heavy-duty trucks. Furthermore, electric charging stations have yet to be rolled out in numbers to make EVs even viable for daily use.”
While EVs may threaten some of Allison’s traditional business, they also represent a potential opportunity.
“Should EVs become more dominant, Allison has already developed an electric axle solution that is in use with multiple awarded platforms, and management assesses this opportunity as three- to ten-times the content per vehicle versus the current offering,’ says Horn.
Top managers also think worries about a business slowdown look excessive. While the business is sensitive to health of customers, some of these risks are offset by the diverse nature of the markets it serves as well as the fact about 30-40pc of revenues comes from municipal government spending.
“In the short term, earnings from the municipal government sector are likely to be less volatile than the commercial side of the operation, which is forecast to see some slowdown,” says Nick Sheridan, top-performing manager of the Janus Henderson Horizon Global Smaller Companies fund. “Longer term, the group has proved itself to have attractive margins and cashflow.”
Allison has also identified several growth opportunities for its business that it believes will generate $400m of extra sales a year.
These include opportunities connected to rising US defence spending and its long-term relationship with the Department of Defense. Mining and fracking companies, meanwhile, are showing increased interest in products aimed at electrification. And new products are being launched for underserved parts of the market.
Having held back on price increases when inflation spiked, the company is now renegotiating contracts. While Allison has powerful customers, with the top five accounting for 52pc of sales and Daimler alone for 18pc, its pivotal place in the supply chain means negotiations are expected to be a source of good news for the rest of the year.
The energy transition has created uncertainties for Allison, but this column agrees with those top managers betting the market is being over-pessimistic about prospects for this highly profitable company and its low-rated shares.
Questor says: buy
Ticker: NYSE:ALSN
Share price: $74.41
Algy Hall is editor of Citywire Elite Companies
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