Lagging Late-Cycle Exposure Can Help Allegion, But The Valuation Isn't Compelling To Me

I wasn’t overly fond of Allegion (NYSE:ALLE) when I last wrote about this leading manufacturer of locks, door controls, and access systems, as I thought the shares were getting a bit too much credit for their end-market leverage. The shares have fallen more than 20% since then, underperforming the broader industrial space by more than 10%, as well as underperforming the shares of the company’s largest rival Assa Abloy (OTCPK:ASAZY) – all of that including a nice post-earnings kick of close to 10%.

I’m conflicted on the shares right now. I don’t really like the valuation all that much, and I don’t think my outlook for 5%-7% long-term revenue and FCF growth is exactly conservative. On the other hand, the company still has lagging price action acting as a tailwind, not to mention late-cycle exposure that investors seem to find strategically attractive today. Still, I’m concerned about the health of the construction markets that Allegion serves, and I’d prefer a wider margin of safety before investing my own money.

 

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Lagging Late-Cycle Exposure Can Help Allegion, But The Valuation Isn't Compelling To Me

Allegion Leveraging Exceptional Resi Strength, As Non-Resi Starts To Come Back

 

The non-residential construction market isn’t fully back yet, but it’s definitely coming back stronger than I expected at this point, and while new starts are relatively easy to measure, it’s been much stronger (and harder-to-measure) aftermarket demand that has helped Allegion (ALLE), not to mention a residential construction market that has been on fire.

Writing on Allegion back in September of 2020 I said that Allegion needed stronger-than-expected end-markets in North America to outperform, and that’s exactly what has happened. That has propelled the shares almost 40% higher since that prior update, though that’s only a little better than the average industrial has done over that time. The valuation remains robust, and while investors are showing a lot of love for longer-cycle plays, I think it may be challenging for Allegion to outperform the expectations imbedded in the price now, as two good quarters haven’t produced much further pop in the shares.

 

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Allegion Leveraging Exceptional Resi Strength, As Non-Resi Starts To Come Back

Allegion - Strong Performance Metrics, But Well-Understood Drivers And Opportunities

Looking at Allegion (ALLE), the one issue that jumps out to me is a potential lack of drivers for better-than-expected performance. Certainly, Allegion has done well in recent years, with a good track record on adjusted operating margin performance, ROICs, and outperformance versus Assa Abloy (OTCPK:ASAZY) in electromechancial locks. I believe that is all well-understood by the Street, though, and reflected in the share price, which leads me to believe that Allegion will really need stronger-than-expected underlying markets in North America and/or a relatively near-term shift towards greater share in areas like Europe and China.

Between both discounted cash flow and margin/return-driven EV/EBITDA, I don’t see Allegion as much of a bargain now, and I see more risk from weaker end-market trends than I see upside from ongoing company-specific drivers. The quality of the business definitely makes it a name to reconsider at a lower price, but that’s not the case today.

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Allegion - Strong Performance Metrics, But Well-Understood Drivers And Opportunities

The Tide Is Turning For Ingersoll-Rand

A year and a half ago, I thought that Ingersoll-Rand (NYSE:IR) looked undervalued, and the shares are up more than 70% since then. Now, to be fair, I thought Atlas Copco (OTCPK:ATLKY) was the better pick at that time, and Atlas's almost 80% rise since then isn't that much ahead of Ingersoll-Rand, so I think this had more to do with being generally right that the market was too worried about the long-term future of these industrial businesses.

In any case, Ingersoll-Rand's management has made progress in both improving the business and shifting the sentiment. I frankly think there's been more progress on the former than the latter, and so there could still be some upside as investors take a more "normalized" view of the company and its prospects (rather than always seemingly expecting something to go wrong). The May 10 Investor Day likely isn't going to be revolutionary for sentiment, but a clear discussion of the company's innovation and productivity initiatives as well as its plans for capital deployment could further strengthen that improving trend in sentiment.

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The Tide Is Turning For Ingersoll-Rand

Seeking Alpha: Assa Abloy Has Growth Locked Up

Assa Abloy (OTCPK:ASAZY) has a lot of the traits that investors looking for high-quality companies ought to prize. The company generates good returns on capital and consistently generates good cash flow from its revenue base. It also has a market leadership position, but operates in a market that still leaves it ample room to expand and grow. While the organic growth rate has been pretty dismal over most of the past decade, the severe disruptions to the construction markets in Western Europe after the collapse of the credit bubble certainly created some headwinds.

The problem (and if there was ever going to be a Stephen Simpson Seeking Alpha drinking game, this is where you'd take a shot) is valuation. Even amidst the crapalanche that is the year-to-date global equity market, Assa Abloy isn't cheap enough for me. Assa Abloy is almost never cheap, and I won't argue that it should be; it's a well-run company with great share. What's more, North American and Western European non-residential and residential construction look like good markets to be in for 2016. Nevertheless, I just can't connect the dots and come up with a valuation that makes me a willing buyer at today's price.

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Assa Abloy Has Growth Locked Up

Seeking Alpha: Can Tyco Break Out Of A Persistent Lagging Trend?

For a company that is supposed to be in one of the more attractive industrial markets, fire and security, Tyco (NYSE:TYC) hasn't lived up to investor expectations. With weaker than average growth and margins, Tyco has been lagging other fire/security players like Honeywell (NYSE:HON), United Technologies (NYSE:UTX), Stanley Black & Decker (NYSE:SWK), and Allegion (NYSE:ALLE) for some time, not to mention the market as a whole (as measured by the S&P 500).

Can the company reverse this unimpressive trend? I can't immediately think of another company in this size range with as much exposure to the non-residential construction market (though Ingersoll-Rand (NYSE:IR) is close), both here and abroad, and perhaps the protracted lull in that market explains some of Tyco's underpeformance. That said, management needs to address what seems to be an elevated level of corporate expenses and a relatively bad track record of meeting projections.

I don't see a large amount of undervaluation here, but this is a significant "self help" story where outperformance on margins can have a disproportionate benefit on the valuation. It's also arguably still at a size where a larger conglomerate could consider it an acquisition target, particularly with the prospect of rooting out the company's elevated cost structure.

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Can Tyco Break Out Of A Persistent Lagging Trend?

Seeking Alpha: With Aerospace Squared Away, Will United Technologies Go Back To Big Deals?

Like the roads around most major cities, the construction of a large industrial conglomerate is never finished. United Technologies (NYSE:UTX) is now strongly leveraged to the expected growth in commercial aerospace over the next decade, but the Building and Industrial Systems segment has suffered in comparison. Like most industrial conglomerates, United Technologies doesn't look like a tremendous bargain at today's levels, but I wouldn't underestimate the potential of a value-bidding deal in the next 12 to 18 months.

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With Aerospace Squared Away, Will United Technologies Go Back To Big Deals?

Seeking Alpha: Stanley Black & Decker Doesn't Inspire Yet

Arguably still best known as a power tools and hand tools company, Stanley Black & Decker (SWK) has spent considerable sums on M&A in the name of diversification. Thus far these deals haven't meaningfully helped the company's returns on capital nor its free cash flow generation, due in no small part to ongoing challenges with its Security business. Although Stanley Black & Decker doesn't look unreasonably valued relative to EBITDA and it has significant self-improvement potential, the shares already price in a lot of cash flow-based improvement.

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Stanley Black & Decker Doesn't Inspire Yet