Rightly or wrongly, investors often think of IPOs as inevitably being hot sales for new tech companies. Facebook (NASDAQ:FB), Kayak (NASDAQ:KYAK), and Yelp (NYSE:YELP) are easy examples of recent vintage high-interest IPOs that came from the tech sector. The results were varied but help illustrate the inherent volatility of stocks in their initial public stages and, hence, the opportunity to profit for traders and investors.
That said, there are plenty of IPOs for "less exciting" companies: banks and retail outfits, industrials and MLPs and so forth. Some of those non-standard, under the radar IPOs offer a better opportunity than more-heralded peers. That opportunity might not be strictly for trading against volatile moves that the heavy-interest stocks see as news changes, but for finding a less known company that is undervalued and worth a long-term investment.
Looking through "post-hype sleepers" - stocks that have been trading for less than 12-months and are trading near 52-week lows and below the initial IPO level (check here for a more detailed definition) - one comes up with a very non-traditional, unsexy IPO: Allison Transmission (NYSE:ALSN). The company is non-traditional as an IPO, standing as a contrast to many of the more talked about, speculative names. Significantly, the company already has shown strong profitability, has forecasted earnings growth, and recently hit a 52-week low (in the middle of July), all good signs for a chance to make a sound trade or investment.
First of all, Allison Transmission is no baby of a company: the self-dubbed largest manufacturer in the world of fully-automatic transmissions for, "medium-and heavy-duty commercial vehicles, medium- and heavy-tactical U.S. military vehicles and hybrid-propulsion systems for transit buses," has been running since 1915. Based in Indianapolis, the company was founded by James A. Allison, one of the original builders/owners of the Indianapolis Motor Speedway, home to the Indy 500. After Allison's death in 1928, the company was bought by General Motors (NYSE:GM), in whose hands it remained as a transmission-making division until 2007. At that point the Carlyle Group and the Onex Corporation bought the division for $5.6B off of the struggling automaker. The private equity firms decided to bring Allison public, which brings us to today.
Allison's business focuses on two segments: on-highway and off-highway. In the former segment, the company claims about 62% of the global market, supplying virtually all the transmissions for school buses as well as significant portions of the class 6-7 and 8 truck, hybrid bus, and motor home markets. Allison's roster of end market users in North America and abroad is impressive, and the company highlights several markets in its latest investor presentation that offer growth possibilities, both domestically and abroad. The off-highway business includes providing equipment for well drillers in the energy industry as well as engines for construction and mining industry vehicles. Allison's non-North America specific segments account for about 17.75% of sales in the first half of 2012, growing at a rate of 15.73% compared to the year prior period, when the international revenue accounted for 16.6% of revenue. Allison especially touts China as a potential growth market, and says fully-automatic transmissions only account for 5% of the non-North America market, offering plenty of room for growth and market share gains. (A deeper dive into the company's business can be found here).
Allison's business is reliant on end users who want to build new trucks and buses, a cyclical market that many have viewed as slowing down. Cummins's (NYSE:CMI) second quarter proved better than expected, but testified along with reports from Eaton (NYSE:ETN) and other major truck parts manufacturers to the slowing growth in the market.
This market slowdown has trickled into Allison's performance. The company's second quarter showed only the slimmest revenue growth compared to 2011 Q2, and showed a decrease in sales compared to the prior quarter (unlike in 2011, where Q2 saw sales growth from Q1). While Allison actually did well in its North American highway business, the off-highway business struggled as low natural gas prices reduced demand for Allison's equipment with end-users such as Schlumberger (NYSE:SLB) and Halliburton (NYSE:HAL). Outside the U.S., Latin America and China were growth markets for the company's highway businesses while Europe unsurprisingly lagged. The quarter came roughly in-line with expectations, with adjusted EPS of $.48 and revenue of $559M a shade over and shade under pre-earnings estimates, respectively.
The quarter highlighted another aspect of Allison's unusual post-IPO story: the company is not a high-flyer, and only expects 1-3% revenue growth for the year, with that growth already achieved. The second half of the year is now expected to show negative growth compared to 2H 2011. These meager numbers follow on years of 9% and 12.3% revenue growth in 2010 and 2011, an indication of Allison's decent prospects but exposure to larger economic trends.
Allison Transmission's Stats
IPO Offering Price
Total Debt-Equity Ratio
Avg. Trading Volume (last 10 days)
359,800 shares daily
Allison is a profitable company, however, and mature enough in its profitability that the stock has started paying a quarterly dividend immediately of $.06, working to an annual yield of about 1.25%. The company pays the dividend while carrying a significant long-term debt load. The good thing for Allison's prospects is that the business generates strong free cash flow, with a conversion rate of 18% of sales. The company boasts of paying down $1.2B in net debt since the Carlyle Group/Onex purchase, and meanwhile has low levels of short-term debt - Allison's current ratio is 1.41 and its quick ratio is 1, suggesting there are no major solvency issues in the short-term, even if the truck market really slows.
On a valuation basis, Allison is quite cheap even compared to other truck parts manufacturers. I've run the numbers against parts makers such as Borg Warner (NYSE:BWA), Tenneco (NYSE:TEN), Gentex Corporation (NASDAQ:GNTX), WABCO Holdings (NYSE:WBC), and CLARCOR Inc (NYSE:CLC).
(Sources: Wall Street Journal, TDAmeritrade, respective company's websites)
As of Q2 2012
Revenue TTM (in millions)
Quarterly Revenue Growth (Q-over-Q)
Quarterly Revenue Growth (Y-over-Y)
Yearly Revenue Growth (1 year prior)
Gross Margin (most recent quarter)
Gross Margin Growth, Q-over-Q (in BPs)
Gross Margin Growth, Y-over-Y (in BPs)
EPS Growth (Annual past two years)
Estimated Earnings Growth (next 3 years)
Earnings 2012 (Est.)
Earnings 2013 (Est.)
Free Cash Flow TTM
P/S for TTM
PEG Ratio (for 2011 P/E)
Price (as of 08/13 close)
(Note: Past EPS growth is only for one year prior for WABCO, Borg Warner, Tenneco, and Allison)
In retrospect, it looks like the company's IPO price of 23/share was a fair value for the business in this low-growth environment: here around 19, Allison is cheaper than each of its peers except Tenneco, and easily the lowest-valued company on a free cash flow basis. This while boasting the strongest gross margin in the group by a large distance, a good sign as Allison looks to expand as a publicly-traded company. On the other hand, the company's PEG ratio is quite high, which involves two issues: the low growth the company expects in a down truck market, and mild confusion among earnings estimates due to a one-time tax gain the company pocketed this past quarter (the Thomson First Call estimate for 2012 includes this gain, for example).
Considering the company has strong free cash flow, a small but not inconsequential dividend, and is still producing decent earnings in a down market, Allison seems to be one of the less risky post-hype sleepers out there. Its current valuation is one reflective of a tough environment, leaving plenty of room for price appreciation when the truck market recovers. At that point, Allison's established market leadership status globally, its build-out in China and Latin America, and its potential to capture new markets should position the company well to grow revenues and subsequently earnings and even dividends.
In looking to anticipate that move, the investor might be wise to pick his/her spot. In the short-term, it seems unlikely the truck market is going to turn around notably, and with much skepticism surrounding the recent rally, it might not take much for a pullback which would dent cyclical valuations. In a sunnier market Allison would likely merit a multiple of 13x 2013 earnings (about on average with its peers' current valuations above), leading to a reasonable target of 22.62/share for Allison in the next 12-18 months (and that not accounting for Allison's ability to beat current estimates in said sunnier market). Getting into the stock at 17 or so, a level it last touched on August 2nd, would be an attractive entry point: 9.77x 2013 earnings, with a 1.4% dividend yield, and with 33% upside and limited downside for the stock.
Allison Transmission's recent IPO was not a typical one. No social media aspects, no technology network ties, and positive earnings and a dividend straight off the bat. But like many stocks off their IPO, Allison has traded below its initial levels. In this case, the company's profitability, market position strength, and free cash flow generation make it an attractive long-term play. Take careful aim with this one, because the investment could well turn into a true win.
Disclosure: I am long ETN.