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:
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.
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.
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.
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.
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.
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.
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.
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.
Source: Seeking Alpha Quant Scores
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.
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