Allegion: Accommodative Industry Trends

Nov. 04, 2021 4:51 PM ETAllegion plc (ALLE)1 Comment
Bashar Issa profile picture
Bashar Issa
3.28K Followers

Summary

  • Allegion is positioned to benefit from an accommodative industry trend manifested in a shift to digital access control systems and locks.
  • The company has historically generated strong cash flows, allowing it to execute its tested capital allocation strategy, which entails dividends, M&A, and debt repayment.
  • Our bullish thesis mirrors ALLE's growth potential, management talent, leading industry position, lucrative cash flows.

Male staff scan the Security card to enter the operating room

Pekic/E+ via Getty Images

Investment Thesis

Allegion (NYSE:ALLE) has had an interesting twelve months after an unanticipated boom in the US real estate market steered the locks' manufacturer away from what I believe would have been an ominous fate, at least from a revenue perspective, a warranted distinction in today's meme-crazed markets.

This year the company received the prestigious Robert W. Campbell award for safety, and the Jackson Lewis award for diversity and inclusion, two awards that distinguish ALLE from competitors and the manufacturing sector, highlighting its leading position in the market.

The well-managed enterprise expects organic growth between 1% to 3% this year, a guidance range influenced by two opposite forces:

  1. Increased demand for access locks due to rise in construction projects
  2. Inflation, and component shortages, hindering ALLE's ability to meet demand

Our bullish thesis mirrors the company's reliable cash flows, growth potential, and management talent weighted against above-average valuation and short-term supply chain troubles.

Revenue Trends

ALLE is positioned to benefit from a moderate rise in demand for digital access control systems across multiple end markets, including residential real estates but more prominently non-residential buildings. The popularity of digital locks stems from their practicality, giving property managers, owners, and businesses flexible, secure, and cloud-connected locks that match their specific needs. The market remains lowly penetrated, opening an opportunity for growth.

Currently, ALLE derives most of its revenue from non-residential markets, including education, hospitality, government, and healthcare. It is one of the few access control suppliers for US intelligence and security agencies.

On a macro-economic level, demand for ALLE's products depends to a large extent on construction activity. This year, total construction spending rose to a multi-year high, fueled by increasing prices and construction volumes in the residential market, and to a lesser extent, the non-residential sector.

The emergence of guest hosting apps such as Airbnb (ABNB) and Booking Holdings (BKNG) is driving more demand for smart homes access control systems that solve more complex access requirements.

Total construction spending in the US

Leading construction activity indicators, such as the ABI index, point to rising demand in the coming quarters. However, ALLE's ability to meet this demand is constricted by supply-chain disruptions, especially in electronics. Economists predict the semiconductor shortage to continue through the second half of 2022.

national business conditions at architecture firms strengthen further into September

Source: AIA Report

ALLE uses steel, zinc, and other non-metallic raw materials, in addition to labor, to produce its goods, all of which are inputs that saw rapid price increases in recent quarters, squeezing margins lower. Along with its peers, ALLE responded by raising prices. However, pricing rates fell below inflation. It seems that the industry is willing to bear some of the inflation costs instead of passing them to consumers. These dynamics point to intense competition and perhaps expectations that prices will return to normal, all of which are indicators of a healthy US economy, at least in my book.

Financial Position

ALLE's share repurchase program is designed to offset dilutions stemming from management equity incentive plans. However, we saw a ramp-up in share repurchases in recent quarters, decreasing the number of shares outstanding by 6%. I am not aware of any change in capital allocation policy, and this might be related to operational discrepancies between repurchases and incentives dispensed during a period. In any case, a lower number of shares is good for investors.

Allegion PLC shares outstanding % change

Data by YCharts

Management increased dividends every year since inception by a CAGR of 30%, and I believe that there is comfortable room for additional growth. The payout ratio stands at a mere 28% of net income and currently yields 1.1%. Overall, ALLE has a solid financial position, supported by a strong stream of operating cash flows. The interest coverage ratio stands at 12x, compared to the sector average of 8x. Profitability is also superior to an average industrial company, with a net income margin of 16%, multiple times above sector average.

Valuation

If you are looking for a bargain, ALLE is not the right stock for you. However, the company's above-average profitability could create low to mid-single-digit returns above the market index. The company trades at an FWD PE ratio of 26x, above the industry average and above what it usually sells for. Similarly, its FWD Sales/EBITDA, EV/Sales are more than %20 above the company's 5-year average ratios.

ALLE valuation grade

Source: Seeking Alpha Quant Scores

Seeking Alpha Quant Score rates ALLE a D in terms of valuation. Given the company's above-average profitability, I believe shares can generate capital gains. Nonetheless, there isn't much cushion for error in this analysis, increasing the trade risk. Conservative investors might want to wait for a pullback, especially given the increasingly pessimistic investors sentiment. Nonetheless, ALLE, as a stand-alone business, is a buy.

ALLE profitability grade

Source: Seeking Alpha Quant Scores

Conclusion

ALLE is benefiting from accommodative industry trends manifested in increasing demand for digital access control solutions and a shift from mechanical to electromechanical locks, increasing opportunities for the company to expand into vertical markets within the digital access controls space. On a macro-economic level, leading indicators point to a healthy construction market boding well for future demand. However, ALLE's ability to meet such demand will depend on developments around supply chains troubles. The company continues to post ballooning order backlog figures. The Federal Reserve's consensus opinion suggests that inflation and supply chain woes will ease in 2022. Our bullish rating mirrors ALLE's growth potential, cash-generative power, accommodative industry, and macroeconomic trends, weighted against above-average valuation and temporary supply chain woes.

This article was written by

Bashar Issa profile picture
3.28K Followers
Bashar is a contributing writer at Seeking Alpha, focusing on Long/Short investment ideas, with a geographic focus in North America. Before that, Bashar worked at an Investment Fund in the United Kingdom. He has a Master's degree in Finance from the Queen Mary University of London and a Bachelor's degree in Economics from Middlesex University.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Recommended For You

Comments (1)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.