Allegion: Maintaining Vision in a Weak Economy. (NYSE:ALLE)

Allegion (NYSE: ALL) have shown strong growth in the face of rising economic winds. The company is poised to grow its organic products by mid-year by 2023. But the economy may worsen, which may suppress the company’s growth. and cash flow margins. The market appreciates Allegion, leaving the company no room for error in the execution of its growth strategy.

Allegion’s growth hits the nail on the head.

Allegion beat its Q1 2023 income estimation by a wide margin. The company posted revenue of $923 million, which was $76.7 million above expectations, and its GAAP EPS was $1.40, which beat expectations by $0.12. The company’s revenue growth was 27% in Q1, driven by sales. The company boosted its revenue and earnings for the rest of the year. It now expects organic earnings growth between 5.5% and 7.5% and EPS between $5.95 and $6.15. The company has beaten EPS figures in the last four quarters.

The company received this high revenue and EPS growth to strong demand in its non-residential North American business and the global demand for its energy solutions. The company attributes the improvement in cash flows and EPS to strong market demand in its non-residential markets, improved supply of energy components and energy costs. The company also sees a shift in security and access control to smart electronic devices, driving revenue growth.

As of June 2020, the company’s profits have increased by 56%, largely due to sales. (Exhibit 1). The company is nearing $1 billion in quarterly revenue, and is targeting $923 million in Q1 2023 (ending March 2023).

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The company’s quarterly gross margins have reached 41.8% as of June 2020 compared to its annual average of 42.6% over the past ten years (Exhibit 1 & 2). But supply chain improvements, strong demand, low inflation, and higher pricing have helped the company improve its gross margins closer to its annual average of March 2023. The company’s GAAP gross margins improved by 184 basis points in Q1 2023 compared to Q4 2022.

Over the past year, I have been amazed at the pricing power of many companies in the industrial and consumer sectors. Most companies have seen volumes decline before double-digit price increases, but the downside costs were less than management expected. In Allegion’s case, the company’s volumes rose 4.4% before the stock rose 10.6%. (Exhibit 3). But the company’s growth was driven by its American division, which increased revenue by 42%, while its Global division saw a nearly 10% drop in revenue and significant decline in margins.

Figure 3:

Cash Flows Are Affected by Too Much Inventory.

Although the company posted record profits and cash flows, operating cash flow was weak due to increased inventory driven by an increase in securities. Its quarterly operating income and margin were $69 million and 7.4%, respectively (Exhibit 4). The company had an average annual operating cash flow margin of 16.3% as of June 2020. The company’s increased inventory levels contributed to lower operating cash flows. The company took 84 days at the end of its March quarter, compared to an average of 67 days over the past decade. (Exhibit 5). Inventory levels are beginning to decline toward the end of 2022. This inventory decline will improve cash flow through the remainder of 2023.

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The company expects to meet its growth targets for 2023. Although the company is optimistic that it will meet its growth targets for the year, it faces many headwinds. Its global share is weak, and demand will continue to be weak. Shopping malls is under severe pressure in North America, and will become weaker if the unemployment rate rises. The commercial real estate market segment is experiencing rising vacancy rates that are pressuring rents, as the cost of capital for these companies has increased. A slowdown in growth could slow down its inventory levels and leave the company with less cash flow than expected.

Great Value

The company’s current valuation provides no defense against uncertainties that could adversely affect its business in 2023. You can buy and sell GAAP PE of 17.6 and a PEG ratio of 3.2x, a high multiple. It trades at a forward EV multiple of 13.5x EBITDA, compared to the median of 10.4x. The stock’s fair value is roughly 10x EV to EBITDA multiple. A 10x EV to EBITDA multiple puts the stock at $90. It may not be a coincidence that the 52-week low is at $87.33. Value metrics tend to indicate that the property is overvalued.

The discounted cash flow model estimates the fair value per share at $105 (Exhibit 6). This model assumes a revenue growth of 4%, a free profit margin of 13%, and an expense ratio of 8%. These thought patterns are relevant for the company. The company carries a debt-to-EBITDA ratio of 2.5x, which is not a high debt level.

Figure 6:

This model predicts lower revenue for 2023 of $3.4 billion, compared to an estimate of $3.69 billion. If the model is based on $3.69 billion in revenue by 2023, the fair value per share is $115, about 4% above the current price of $110.48. The high growth rate that the company is predicting is unlikely to be sustained for long, so the 4% assumption is reasonable. The US economy increased by only 1.1% in Q1 and expect growth to improve to less than 4% pace for the rest of the decade. A 4% growth rate will make the company grow faster than GDP. Investors need a safe place to value a property, and Allegion is the exception. The fund is now highly valued, and investors may consider investing in it if it returns to the mid-nineties.

The price is low, the sales are low, but the price growth is good.

The fund will yield a yield of 1.6%, which is much lower than the yields available on US Treasuries. The company has a 27% payout ratio and has grown its payout by 19% over the past five years, a healthy growth rate. The company has spent $588 million on share repurchases since September 2020, which reduced 4.3 million shares for a purchase price of $136. (Source: Alpha Search, Author Count). The company may have overpriced its stock, as it is close to $90 per share.

Economic growth is accelerating worldwide, with the latest US GDP growth showing a significant slowdown. The stock market volatility, as measured by the S&P VIX Index (VIX), is at 15.7, indicating positive. These market conditions can change over time. Long-term investors looking to buy Allegion may be disappointed if they buy Allegion at current prices. A slower US economy and rising volatility may be a better way to buy this stock at a lower value.