I wrote previously about companies Berkshire Hathaway could potentially buy. One of those options actually was acquired, just not by BRK. But I think Allison Transmission ($ALSN) is another strong candidate. Why do I say that?
- ALSN is the market leader in fully automatic transmissions for medium-to-heavy duty commercial vehicles
- They do not play in the super cyclical Class 8 truck market
- Because of market dominance, they have great margins: ~35% EBITDA margins and spend 6% of sales on capex
- Generates high ROIC (>20%) and even higher returns on tangible capital
- It’s a classic industrial, but misunderstood, which has it trading in melting ice cube territory wayyy too early
- Mgmt has been solid capital allocators, though the stock price doesn’t reflect this yet
I recently initiated a position in ALSN. It came up as I decided to update my model (right after I did some quick work on American Axle) and noticed that the share count had reduced from ~120mm to 106mm in a pretty short period of time… but the stock was actually lower than the last time I looked at it.
I think there are many reasons to own the stock now, not least of which is a cyclical upturn in their end markets, but wanted to frame it differently for this discussion. It’s a “small” company at ~$6.5BN EV, but I don’t think that would stop Buffett.
ALSN is the Market Leader:
Allison invented the automatic transmission for commercial applications and there’s been a long trend in the West away from manual transmissions.
It doesn’t matter as much in long haul, but constant starting and stopping can be annoying with a manual and Allison’s transmissions can also be more fuel efficient (lots of start and stop activity).
So who do they compete with? Well, their main customers are OEMs. Typically, their competition comes from OEMs who decide to do this in house, like Ford. Other competitors are smaller players that clearly don’t compete on the same scale.
This is mainly the North American market, so it should be noted Europe (13% of sales vs. 52% North America) has more vertically integrated players for these commercial vehicles, particularly the commercial trucks. So ALSN’s exposure in Europe is mostly garbage truck, emergency vehicles, bus and other markets.
ALSN, though, is viewed as the leader of technology and is often the most desired transmission.
I won’t dwell too much on their other markets (defense at 9% of sales, which is mostly tanks, or off-highway which is mostly construction and metals & mining exposed, but just 4% of sales).
I will say service, parts and equipment is the second largest part of sales (22%). I like this piece of business because aftermarket provides a nice, steady recurring revenue – driven by the large installed base of transmission already in existence.
ALSN has Great Margins
As mentioned, ALSN has ~35% EBITDA margins. That is actually down from peak due to (i) lower sales LTM, (ii) increase commodity costs, (iii) product mix, and (iv) a ramp in R&D expense. Given dominant share and a recovering market, I think they’ll work their way back up to high-30s EBITDA margins.
That said, the market is completely freaked out about EVs and lower margins in that category. For ALSN, it is the number one bear case. It was asked about 3 separate times on the latest earnings call, despite the existence of electric vehicles still being relatively nascent (I won’t hold my breath for the electric tank either).
This does tie into the misunderstood point, which I hash out below.
ALSN Generates a Great ROIC
Note, ROIC does get hit in cyclical downturns (2014-2016, 2020), but through cycle it is well above ALSN’s cost of capital and run-of-the-mill businesses. Enough said.
ALSN is a Classic Industrial, but Misunderstood
I think its pretty clear that ALSN is a classic industrial. An old school business. Maybe not classic given its high margins and dominant position in its market, and many, many industrials struggle to generate good returns without a lot of leverage.
ALSN does have many growth avenues, such as emerging markets which still have high manual transmission penetration. Second, there are underserved portions of the North American market it could enter, shown on the previous market share slide.
But the market is completely freaked out about EVs.
As I wrote about with Autozone, the penetration of EVs will take some time to work out in the passenger car market. The misperception with Autozone is that the market forgets how big the car parc of ICE engines is compared to new production.
It will, in my view, take even longer to happen in commercial. Add in the fact that these trucks consume so much energy from towing, it really will be tough to figure this out.
But why freak so much about EVs? Its because EVs don’t require a transmission and Tesla’s Class 8 truck doesn’t have a transmission. There. That’s the bear.
That said, ALSN is already the leader in hybrid transmissions (particularly hybrid buses), they have frequently highlighted examples where Allison transmissions have been used in electric trials over the past FIVE years, and there is a strong case that commercial EVs may benefit from a transmission (it could likely reduce the strain on electric motors, thereby reducing the need for larger, heavier batteries).
Is it a threat? Sure. I think EVs are inevitable. But will it take time? Yes. And the costs side has to be figured out so much more so on the commercial vehicle side than the passenger side (let’s not even talk about how we’re going to mine all these precious minerals for EVs…). And let’s not forget nearly a quarter of ALSN’s business is parts & services too, which will continue to benefit from a large installed base.
Maybe I’d be more concerned if ALSN had no position, had no experience, and the commercial vehicles were here and rapidly taking share. Maybe I’d be more concerned if ALSN wasn’t a FCF monster. But ALSN is priced as if this doomsday is already the case.
Mgmt has been excellent at capital allocation
It isn’t everyday that you come across a slide like this. First ALSN got their debt down after being PE owned. Then they continued to paydown debt after IPO’ing, but largely turned to share repurchases, dividends, and modest M&A. It’s pretty clear to me, that while the company is increasing spend on R&D, every dollar of FCF will be coming back to shareholders.
They repurchased 5% of their stake in the 1H’21… they’ve repurchased 50% of their shares outstanding since 2012! All while delevering, not levering up.
Back to Berkshire – look, if this cash is better spent on other businesses, let Buffett make the call. But at this point, the market is just not giving them credit for the cash!
Why buy the stock now? You make your own call, but for me, we are witnessing a cyclical upswing. ALSN will be growing sales and EBITDA for at least the next 3 years just to get back to a baseline.
Using consensus FCF numbers, ALSN currently trades at 14.5% FCF yield on 2022 FCF estimates and 15.7% on 2023. This likely means they’ll be buying ~12% or so of the stock back + the dividend. With that much buying pressure, plus a cyclical upswing, I think it is very hard for a stock to NOT work.
On EV / EBITDA, ALSN trades at 6.5x ’22 EBITDA. I regularly see paper companies trade for around that. That seems too cheap to me.
Sponsors have owned the business before and they may own it again. It can support a lot of leverage…Or, Mr. Buffett might give it a look.