|Shares Out. (in M):||138||P/E||11||10|
|Market Cap (in $M):||5,391||P/FCF||9||9|
|Net Debt (in $M):||2,347||EBIT||735||745|
This report is for information purpose only and does not serve as investment advice.
ALSN has been written up a few times on VIC. I think it is interesting here given the FCF outlook and rapidly shrinking share count. If you are familiar with the company and its attractive investment characteristics, you can skip ahead to the section on why I think it is mispriced.
Allison Transmission (ALSN) has a near monopoly in fully automatic transmissions for medium- and heavy-duty vehicles which enables exceptionally high profit margins and excellent free cash flow generation. The company has reduced its share count by 16% over the past year and is expected to continue to aggressively repurchase stock. The current price represents ~9x forward free cash flow and provides an opportunity to invest in a dominant market leader while collecting a double-digit total shareholder yield.
What does the company do?
Allison Transmission (ALSN) is the world’s largest manufacturer of fully-automatic transmissions for medium and heavy- duty commercial vehicles and medium- and heavy-duty tactical U.S. defense vehicles. ALSN introduced the world’s first fully automatic transmission for commercial vehicles over 60 years ago. Since that time, the Allison brand has become one of the most recognized in the industry because of performance, reliability, and fuel efficiency and is associated with high quality, durability and technological leadership. The company has developed over 100 different models that are used in more than 2,500 different vehicle configurations. The products are highly engineered, requiring advanced manufacturing processes and employ complex software algorithms for transmission controls to maximize end user performance.
The company was founded in Indianapolis, Indiana in 1915 and was an operating unit of General Motors from 1929 until 2007. Onex and Carlyle Group purchased ALSN in 2007 and took the company public in March of 2012.
What are ALSN’s end markets?
ALSN sells into a variety of end markets globally. The below chart provides a break down of 2017 sales.
· North America On-Highway- 49% of sales. ALSN’s core on-highway market includes Class 4-5, Class 6-7, and Class 8 straight trucks, conventional transit, shuttle and coach buses, school buses and motorhomes. The company sells substantially all its on-highway transmissions to OEMs.
· North America Hybrid-Propulsion Bus- 3% of sales. ALSN manufactures transmissions for electric hybrid transit buses sold to city, state, and federal government entities.
· Global Off-highway- 4% of sales (2% in North America and 2% ex-North America). ALSN provides products used in equipment for energy, mining, and construction applications. Energy-related applications are the main driver of the segment and include hydraulic fracturing equipment, well-stimulation equipment, pumping equipment, and well servicing rigs.
· Outside North America On-highway- 15% of sales. Fully-automatic transmission penetration outside of North America is significantly lower and represented less than 5% of vehicles and is concentrated in certain vocational end markets. ALSN’s outside North America exposure is composed of 41% APAC, 7% South America, and 52% EMEA.
· Defense- 5% of sales. ALSN has a long-standing relationship with the DoD dating back to 1946. Today, the company sells substantially all the transmissions for medium- and heavy tactical wheeled vehicle platforms. ALSN is also the supplier on two of the three key tracked vehicle platforms, the Abrams tanks and the M113 family of vehicles.
· Service Parts, Support, and Other-24% of sales. ALSN sells branded parts and fluids, remanufactured transmissions, and support equipment through a world-wide network of approximately 1,400 independent distributor and dealer locations. The aftermarket provides the company with a relatively stable source of high margin revenue as the installed base continues to grow. Uninterrupted operation is critical for end user’s profitability which often results in aftermarket purchase decisions being less price sensitive.
Quick Note on Track Classifications
Commercial vehicles are categorized into classes based on gross vehicle weight rating, or the maximum weight a vehicle can carry. In the US, these range from Class 1 to Class 8. Class 1-3 are standard pickup trucks (e.g. Ford F150-F350) and are considered light duty. Class 4 through 6 are larger medium duty trucks and can carry between 14,000lbs and 26,000lbs (e.g. medium-sized box truck). Class 7 and 8 are considered heavy duty and can carry over 26,000lbs (e.g. large construction or dump truck). Class 8 is further broken down into Class 8 straight and Class 8 tractor. Straight refers to trucks with a unified body (e.g. refuse, construction, and dump trucks) while tractor refers vehicles with a chassis that is separable from the trailer they pull. ALSN’s core on-highway market includes Class 4-5, Class 6-7, Class 8 straight trucks, conventional transit, shuttle, and coach buses, school busses, and motorhomes. The company has virtually no exposure to Class 8 tractor.
Why does a fully-automatic transmission matter?
Commercial vehicles typically use one of three types of transmissions: manual, automated manual (AMT) or fully-automatic. Manual is the most prevalent type used in Class 8 tractors in North America and in medium- and heavy-duty commercial vehicles outside North America. Manual transmissions utilize a disconnect clutch causing power to be interrupted during each gear shift. This results in energy loss-related inefficiencies and less work accomplished for a given amount of fuel. In long-distance trucking this power interruption is not a significant factor since the manual transmission provides the best fuel economy in steady-state cruising. However, in truck applications that require a high degree of start and stop activity, manual transmissions can result in lower fuel efficiency, reduced performance, inferior ride quality, and lower average speed for a given amount of fuel consumed. Additionally, clutches must be replaced regularly resulting in maintenance expenses and vehicle downtime. Finally, manual transmissions require skilled drivers to operate which can limit a fleet operator’s potential talent pool. This is an important consideration given the on-going nationwide truck driver shortage. Additionally, as of three years ago, one can now receive a commercial driver license that only qualifies you to drive with an automatic transmission.
AMTs are manual transmissions that offer automated operation of the disconnect clutch. By contrast, fully-automatic transmissions utilize technology that smoothly shifts gears instead of a disconnect clutch, which delivers uninterrupted power to the wheels. While AMTs offer some advantages relative to manual transmissions, they still offer inferior acceleration, lower productivity, higher maintenance costs, and reduced fuel efficiency in vocations with a high degree of start and stop activity relative to fully automatic.
Given the benefits, ALSN can charge a premium price, especially in its heavier duty products. Its transmissions sell for between $3,000 and $11,000 versus AMTs in the $3,000- $7,000 range. While the initial price tag is higher, total cost of ownership is lower since it requires less frequent maintenance, no need to replace the clutch, and higher productivity. ALSN estimates the average payback period for a premium transmission is less than 3 years. The product’s durability and long lifetime can also materially benefit resale value, which is an important consideration for end customers who periodically upgrade their fleets. ALSN’s fully automatic transmission’s value proposition is evident in the company’s North America Class 8 Straight market share which has steadily increased from 50% in 2012 to 68% in 2017.
Why own the stock?
ALSN is the dominant market leader in fully-automatic transmissions for medium and heavy-duty vehicles. Its products are the “de-facto” standard for end users who want fully-automatic. In Class 8 Straight (23% of total revenue), the company’s market share (defined by units with an ALSN divided by total units produced) has steadily increased from 50% in 2012 to 68% in 2017. There are no other heavy duty fully-automatic competitors and the company has succeeded in taking share from manual and AMT due to the productivity and fuel efficiency benefits. The market share numbers are even higher in Class 6 and 7 (71% share and 14% of total revenue) and school buses (88% share and 5% of total revenue). In my diligence I interviewed a number of truck dealerships and the constant refrain were statements like: “I am not aware of any other competitors”, “They are the 800lbs gorilla”, and “Allison in the only option.” A parts director at one dealership even said, “They can sometimes be difficult to deal with because they know they are the only game in town.” The company’s technological leadership, long-term OEM relationships, dominant niche market position, and reputation for quality serve as substantial barriers to entry to any potential competitors. The company’s IR deck highlights the virtuous market leadership fly-wheel: