Company Background

Allison Transmission (ALSN or Allison) came up on my screen recently. I’ve heard of this name but never dug deeper. ALSN is based in Indianapolis, Indiana, and was founded in 1915. From 1929 until 2007, it was part of General Motors (GM) until it emerged as a standalone company. In 2012, Allison began trading on the New York Stock Exchange.

According to its annual report:

[Allison is] the world’s largest manufacturer of fully-automatic transmissions for medium- and heavy-duty commercial vehicles and medium- and heavy-tactical U.S. defense vehicles.

In 2018, Allison had 60% global market share of fully automatic transmissions. Allison’s largest sales come from medium- and heavy-duty commercial vehicles. These vehicles include school buses, garbage trucks, fire trucks, and distribution trucks. What’s interesting is most of these vehicles still use manual transmissions. Does anyone remember those? When I first purchased my brand new Emerald Green (don’t ever buy nonstandard colors especially when given other options) 2000 Honda Accord Coupe in high school, the salesperson offered me automatic and manual. I was smart enough to choose automatic which was handy for eating and drinking (nonalcoholic beverages) while driving. Nowadays manual transmissions are extinct for passenger cars because it’s too much work, especially for stop-and-go traffic, less efficient for practically every driver, and higher in maintenance costs (i.e., I’ve ground many clutches while trying to learn).

For long-haul shipments putting the truck in high gear the whole time might not make a lot of difference, but if the duty cycle requires more than just cruising speeds this can be huge. According to the Company,

When the duty cycle requires a high degree of “start and stop” activity or speed transients, as is common in many vocations as well as in urban environments, we believe manual transmissions result in reduced performance, lower fuel efficiency, lower average speed for a given amount of fuel consumed and inferior ride quality.

From a macro view, this Company stands to benefit – perhaps, for years to come.

By the Numbers

The Company’s balance sheet initially seems over leveraged with equity of $659M and long-term debt of $2,523M. However, interest coverage is solid at 7.6x (the Company earns its interest cost 7.6x over) and has strong cash flows from operations ($837M). Overall, gross margins, operating margins, net income, and everything seems to be on the up and up. Operating margin is clocking ($923M / $2,713M =) 34%. To put this in perspective, generally, decent operating margins are 10%, good is 10-20%, and over 20% you’re in a very good business.

Let’s talk about return on capital, key metric that Warren Buffett, and his lieutenant Ted Weschler use. Both use slightly different variations but get at the same point. Buffett is famous for using return on tangible equity (ROTE) and Weschler for return on invested capital (ROIC). These metrics measure how well a company efficiently deploys capital and has tremendous¬†long-term repercussions. Capital deployed efficiently can compound over decades and be exponential.

Quick numbers from Allison’s 2018 10K:

  • Operating income: $923M
  • Net operating income after tax (NOPAT) assumes 21% tax rate (thanks Trump!): $923 x .79 = $729M
  • Net working capital (Net W/C): $170M
  • Carrying value of property, plant and equipment (PPE): $466M
  • Invested Capital (Net W/C + PPE): $170M + $466M = $636M
  • ROIC = NOPAT / Invested Capital = $729M / 626M = 116%

Conclusion

Trucks and vehicles Allison serves aren’t going away. Allison is the global leader in the fully automatic transmission space however most vehicles are still manual. Not coincidentally, ALSN had year over year sales growth of 17% in 2018. I would expect this company to do well and outperform the S&P 500.

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