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Allison Transmission (ALSN): A Cheap, High Cash-Flow Business With a Decent Moat

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Allison Transmission Holdings (ALSN)

Price:  $43.24

On a week like this with the S&P 500 down almost 8% from its all time highs and the fears associated with the coronavirus possibly plunging the world into an economic depression, I thought it’d be prudent to go bargain hunting in the stock market.

A name I’ve been looking at for a while is Allison Transmission Holdings (ALSN).  It’s the world’s largest manufacturer of fully-automatic transmissions for commercial vehicles.  It’s considered the “de-facto” standard in North America, the “best of the best” as far as automatic transmissions go.  They really have no large-scale  competitors making these products.  Its quality name has given Allison the ability to charge premium prices and even raise prices over the years without affecting sales.  ALSN sells their products for use in military vehicles (the M1 Abrams Tank), fire and emergency vehicles, school and public transportation buses, mining trucks, agricultural vehicles, and more.

The ongoing trend is that more commercial vehicles are transitioning to automatic transmissions for ease of use, safety, and fuel efficiency.  Globally, Allison sold about 60% of the automatic transmissions for medium and heavy-duty on-highway commercial vehicles.  They still have a long runway for growth as most commercial vehicles in emerging markets are manual.  Allison is also the #1 supplier of fully automatic transmissions in China in which fully-automatic transmission penetration is less than 5%.

ALSN’s fully automatic transmissions improve driver efficiency, so it reduces the need for drivers to be skilled at shifting in manual.   Its transmissions also provide better fuel efficiency.  Because of these advantages, Allison’s transmissions can pay back the $3,000-$11,000 up-front cost over manual transmissions in less than three years.

ALSN has an asset-light business model in that it requires very few assets to generate high returns on capital.  They can simply reduce or increase their capital expenditure spending in response to demand.  It’s a variable cost structure which is ideal to a fixed cost structure.

Their economic moat comes from their numerous patents, strong 50-year brand name that’s recognized around the world and their customer relationships with some of the top vehicle manufacturers worldwide.

Financial Stats

Hearing all this, one might think this company is very richly priced by the financial markets.  But you’d be wrong.  Allison trades at a cheap price to free cash flow (P/FCF) multiple of 8, an enterprise value to ebitda (EV/EBITDA) multiple of 7, and a P/E of 9.  (Based on fiscal year 2019 numbers).

Over the past 3 years their revenue has increased by 47% and their operating income by 97%.  Free cash flow over that period increased by 30%.

ALSN’s return on equity and return on capital are also fantastic.  Their ROE for 2019 was 91% and their ROC was 49%.  (Calculated as Equity+Debt-Goodwill).  Another interesting statistic is that they’ve reduced their share-count by about 30% over the past 3 years.  Return of shareholder capital with buybacks and dividends as well as reducing debt has been a priority for them.

I frequently like to seek out companies that have been free cash flow positive for at least 8 years straight.  Allison Transmission has been free cash flow positive for 10 straight years.  In almost all those years, they’ve paid a dividend, bought back shares, or both.

Another stat I like to look at is how well a company translates its revenue into free cash flow.  For fiscal year 2019, ALSN had a free cash flow conversion rate of 25%.  That’s a fantastic number for any company to achieve.  This means that 25% of their revenue turned into free cash flow that the company could use for dividends, buybacks, or to reduce debt.  (FCF/REV)  These numbers have been remarkably consistent over the years.

ALSN’s operating margins are excellent as well, being 33% for 2019 and close to 30% in previous years.

Something to monitor is the trend toward electrification of commercial vehicles, which could challenge ALSN’s moat.  Over the past 15 years, Allison has delivered about 8,000 hybrid-electric bus powertrains.  They’ve also made a couple acquisitions, namely AxleTech and Vantage Power for their electric powertrain intellectual property.  Full electrification of commercial vehicles is still at least 10 years away and Allison seems to be making the right moves to prepare for that.

Overall, ALSN’s cheap valuation metrics, great returns on capital, consistent free cash flow, shareholder-friendly buybacks, and decent moat make it a low-risk investment that could generate solid returns and compound your capital over many years.

Disclosure

RTN Investments holds a position in Allison Transmission Holdings stock.  This article is not meant to be investment advice.  Do your own research before investing.


Robert Nowak is the founder of RTN Investments, LLC.  RTN is a registered investment advisory managing separate accounts for clients and is modeled after Warren Buffett’s original partnerships.  RTN’s goals are the preservation of client’s capital and to outperform the S&P 500 on a rolling 5 year basis by investing in undervalued stocks of high quality companies.