Tag: ALSN

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Leaning into Value Traps that Everyone Hates… and a New Name, Strattec $STRT $AXL $ALSN $CATO $ANF
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There are certain businesses that investors have washed their hands of: Retailers, OEM auto suppliers, anything in the way of ESG… many others… And this trade probably worked well for the last 5 years. I recently wrote up at least three names that are counter to these trends, but there are many more.

I’m in the process of creating a “basket” of these names that I’m going to commit to buying and holding for at least 3 years.

I’m calling it: the Value-Trap Coffee Can portfolio.

Most of the time, a coffee can portfolio is set up of really good businesses that you should just set and forget. Let them compound.

In this case, the narrative around some stocks can be so toxic, you can convince yourself at any point to sell. But if find management teams that are very savvy, conducting effective turnarounds despite headwinds, and know how to drive shareholder value, sometimes you still want to align with them.

I fundamentally believe you can have bad industries, but great companies (driven by great management teams) and therefore great securities hidden within them. 

So I’m locking these stocks up and throwing away the key to see what happens.

So far, the Value-Trap Coffee Can (VTCC for short) portfolio includes Allison Transmission, Big Lots, and American Axle, but I am also adding Cato (recently discussed on Andrew Walker’s podcast with Mike Melby at Gate City Capital), and Abercrombie and Fitch (written up on VIC, but down nearly 20% since then). After looking into the latter two, I’m convinced they’ve earned their spot. They aren’t my ideas though, so I won’t be writing them up.

I am adding Strattec to the VTCC portfolio, which is an automotive supplier and I’ll get to at the bottom of this note.

Please reach out if you have any others I should be looking at!

Why the VTCC Portfolio Now?

At points in the past, this would’ve seemed nuts, but my response to that is these companies

  • have significant cash / FCF, especially compared to their market caps today
  • have a rising earnings path over next ~12+ months. Especially true now that we went through a downturn and are coming through on the other side of it, and
  • are completely unloved, so are still very cheap.

You can see it’s really more of a cycle + cheap call.

I cover cyclicals for my day job and cyclicals have been pretty much un-ownable since we had an industrial-recession scare back in 2015/2016. OK – they had a nice run when Trump first came in, tax cuts were implemented, and there was a brief sugar high – but after that, the stocks didn’t do well by comparison even if results were fine. I saw many companies I covered trade at super low multiples as everyone figured a cycle was inevitable.

I now think that since we may be entering a new cycle, permission to own is granted.

In other words, maybe value traps won’t be traps for too much longer. (Famous last words DillyD!) But seriously, you can mitigate this problem via position sizing.

A couple pushbacks to that simple thesis:

  • You could completely disagree with me that we are entering an upcycle – people are already saying what we went through in 2020 doesn’t count as a “normal” recession (whatever that means) and is more like a natural disaster. Semantics. Whatever. This is the theory I have and am going to bet that way.
  • Stocks already at all-time highs, too. So how can there be much of a recovery? Well… FANG is like 25% of the S&P500. None of these basket stocks are in tech.
  • Supply chains are a mess. This could derail the thesis, but I think it would be a temporary derailment vs. anything long-term.

It seems very hard to argue to me that any of the sectors I am going to buy a basket of are “overbid” territory. We can also reach new highs if FANG stocks stay flat and cyclicals have a really nice run, too, ya know?

I think retail is interesting because the consensus narrative was that they are dead, that we pulled forward a ton of e-commerce progress… and yet, if you actually looked at some of these player’s results, you’d see they either adapted very well (some did) or the buyer is coming back.

The anti-ESG trade is only interesting to me in names that can solve the problem – by buying back stock themselves at really attractive prices. Some names are in the ESG crosshairs, but either can’t or are unwilling to effect change in their share prices.

Why Strattec?

Strattec is an interesting little auto supplier that makes locks, power lift gates, latches, among other things. It was originally spun out of Briggs & Stratton in 1995. Here’s a [kinda hilarious] video of them trying to sell why people need a power lift tailgate.

They have their OEM concentration issues, like American Axle, but that is the name of the game. They actually have much better concentration than American Axle which you can go see in their 10-k.

Similar to my American Axle thesis, I think we are going to need a massive restocking of cars. Inventory days are ~22-23, compared to the normal 50. However, this cycle is going to take a long time to sort itself out.

Unfortunately, Strattec was impacted by plant shutdowns due to lack of semiconductors. This is disappointing as the company wasn’t able to sell as much, particularly in its award winning power tailgates in the Chevy Silverado and F-150 pick-ups.

But it’s a double-edged sword. The longer it takes to replenish inventories to “normal” the longer this auto upcycle will likely last. Yes, less sales today, but I think the tailwinds will be there for some time to come. Again, I wrote about all of this in my AXL post.

Even with these headwinds, Strattec still did $110MM in the latest FQ4 (ended June, reflecting the impact of the semi issue) and $485MM for the FY, down from $129MM in the quarter ending June 2019, but in-line for the FY $487MM. However, EBITDA increased by ~50%. Again, this was due to cost improvements and efficiencies in the business that the company says is structural.

Bottom line, I think Strettec will emerge more profitable than ever, and if permitted to run flat out (semi issue abates somewhat) then we will see awesome fixed cost leverage, too.

Strattec Valuation:

Strattec is only a $150MM market cap company, but an enterprise value of ~$147MM.

Over the past 12 months, they cut their dividend during the COVID panic and paid down $23MM in debt. If you fully count JV debt, they have $12MM in debt now, but $14.5MM in cash.

At the same time, let’s say you expect the top line to grow a bit, but they’ll give some margin back, the company is trading <3x EBITDA. And it isn’t like that EBITDA won’t convert into FCF: the company has guided to $12MM in capex, they’ll have no interest expense (basically) and taxes in the range of $8-10MM. That’s $35MM of FCF on a $150MM market cap company.

Not bad! Just last 4-5 more years and I’ll have my money back.

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Why $BRK Should Buy $ALSN
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I wrote previously about companies Berkshire Hathaway could potentially buy. One of those options actually was acquired, just not by BRK. But I think Allison Transmission ($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: 

This is a great slide covering ~50% of their sales, showing their dominance in “niches.” I love businesses like this.

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.

ALSN IPO’d in 2012, so you can see they clearly turned cash to repurchases

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 Now?

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.