Allison Transmission Holdings (ALSN, Financial) designs, develops and manufactures medium- and heavy-duty fully automatic transmissions and hybrid propulsion systems that are used in various industries, including agriculture, construction, defense, energy and mining, just to name a few. As electrification seems to be the future of mobility, the company also has a series of electric vehicle solutions, offering zero emissions and electrifying performance. There are plenty of reasons to like the stock now in my opinion, starting with an attractive valuation, solid profitability and the launch of new business solutions that are expected to drive growth.
Robust fundamentals and a strong technical trend
I think there are many things to like about the fundamentals of this company, and one is that it has a high debt-to-equity ratio. Allison Transmission's debt-to-equity ratio for the three months that ended on March 31, 2023, was 2.53. Having too much debt is often a path that leads to financial distress if a company cannot generate strong positive free cash flows to repay its debt, but Allison Transmission has been reducing its debt-to-equity ratio steadily since December 2021. Back then, the debt-to-equity ratio was as high as 3.95, so there has been an important improvement in strengthening the balance sheet.
The liquidity looks fine in the near-term as the current ratio is 1.98 and the quick ratio is 1.49. As long as these values are higher than 1.0, then there is no significant immediate risk for solvency.
Allison Transmission has generated consistent (though volatile) free cash flow over the past five years. After a drop of about 36% in free cash flow in 2020 to $436 million, there was an increase of 5.50% in 2021 to $460 million and another increase of 6.52% in 2022 to $490 million.
The company has been improving its profitability since March 2021 as both the net margin and operating margin have widened. Back in Late March 2021, the net margin was 13.78% and has climbed to 20.19% as of March 2023. The operating profit grew from 24.56% in March 2021 to 28.66% in March 2023. As we can see, the company recovered well from the Covid market crash and benefitted from the spike in demand for automobiles.
The return on assets and return on equity also confirm robust profitability. The latest figures for Allison Transmission's ROE and ROA for late March 2023 were 67.83% and 12.28%, respectively. These numbers exhibit a rising trend over the past eight quarters.
On another note, Allison Transmission has a robust history of earnings beats, surpassing earnings estimates in three of the last four quarters, which is very positive for helping promote investor enthusiasm.
The technical trend shows that this stock is getting noticed as it has gains of nearly 29% year-to-date and about 21% over the past three months. The stock has been trending over a rising 50-day and 200-day simple moving average and the MACD indicator seems very bullish as it is rising and is positive.
Allison Transmission is expanding its operations to China
China is home to the world's largest population, so it is no wonder that Allison Transmission has announced it will enter the energy sector there. The company has big plans for its next-generation hydraulic fracturing transmission named FracTran. According to the company:
“Initially introduced in North America in 2021, the FracTran’s expansion into China signifies the strong demand Allison is experiencing outside of North America, particularly in the energy sector, and represents an incremental growth opportunity of $100 million dollars in annual revenue for Allison’s global Off-Highway end market.”
The company also announced that “it has been selected by Southern Waste Management Environment Sdn Bhd (SWM), the largest waste management provider in Malaysia, to enhance the efficiency of their refuse collection operations.” The company stated, “We look forward to a continued partnership with SWM and to further advancing the refuse collection industry in Malaysia."
The key word is continued as it simply means recurring revenue and not just a one-time event of selling products and services. In terms of business, having recurring revenue adds more safety than receiving a large amount of capital that probably will not be repeated. It has to do with trend analysis. A company that receives revenue over time from foreign markets in this example bears the foreign exchange risk but at the same time it increases its total revenue, which is great in terms of diversification and reducing risk from exposure in just a few markets.
Valuation looks great now
As of this writing, Allison Transmission has a price-earnings ratio of 8.72, which is considered relatively low and is a signal that this stock may be cheap. Even better, the stock has a non-GAAP PEG ratio of only 0.23. This is well below the fair value level of 1.0, signifying undervaluation.
Based on Wall Street's predictions for future earnings results, the stock has a forward enterprise-value-to-Ebit ratio of 8.01 and a forward price-to-free-cash-flow ratio of 6.92. In comparison, the median values for the industrials sector are 15.21 and 12.89, respectively.
To summarize, I believe Allison Transmission's stock looks cheap, the company's profitability is robust and it is making strategic moves to expand business operations. This is a very positive environment.
