Allison Transmission Grinding Through A Rough Patch

The North American commercial truck market is still in pretty rough shape. While August vehicle orders showed sequential growth for both Class 8 trucks (up 37%) and Class 5-7 trucks (up 10%), both were down on a year-over-year basis (down 29% and down 5%, respectively). For Class 8 trucks, that's a year and a half of consecutive Y-O-Y declines in the monthly numbers, while Class 5-7 trucks have seen negative annual comps in three of the last four months.

That's a tough backdrop for Allison Transmission (NYSE:ALSN), the leading manufacturer of automatic transmissions for heavy-duty vehicles, but Wall Street has minded too much. While the shares are down a bit over the past year, they are up almost 20% from my last article, just a little below Cummins (NYSE:CMI) and Twin Disc (NASDAQ:TWIN), though the latter has been much more volatile. Investors seem to be encouraged by Allison's ability to retain strong share and good margins through this downturn, as well as the prospects for increased share on product roll-outs by customers like Navistar (NYSE:NAV) and PACCAR (NASDAQ:PCAR).

I still like Allison. It's not tremendously undervalued relative to the operating and macro risks, but it is priced for double-digit returns. More to the point, management seems to be following a sensible plan and one that I think can add share in important under-penetrated markets like metro Class 8 and international over time.

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Allison Transmission Grinding Through A Rough Patch

Seeking Alpha: Sentiment May Be Gaining On Allison Transmission

I was bullish on Allison Transmission (ALSN) in early October ("Allison Transmission A Stand-Out In Multiple Ways"), and I cannot complain about the 18% move since then as it has outpaced the S&P 500 and other truck component companies like Cummins (CMI) and Dana (DAN). Management has recently confirmed that improving North American truck orders are starting to flow through to their order books and that the fracking market is coming back to life.

I still really like the long-term idea of Allison as a share-gainer in the commercial vehicle transmission market, but I am a little concerned that analyst and investor enthusiasm is running ahead of the underlying vehicle markets. A 12x EBITDA multiple only gets the stock to about $30 and that's a pretty strong multiple relative to the company's likely growth rate. There is certainly a chance that the recoveries in Allison's markets will lead to outperformance and/or that the company will gain share in OUS markets faster than expected, but I don't see Allison as quite the bargain it was about six months ago.

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Sentiment May Be Gaining On Allison Transmission

Seeking Alpha: Fracking Will Recover, But Can Twin Disc Achieve Better Margins?

I really want to like Twin Disc (TWIN). Not only does this small and almost unfollowed company make the sort of heavy industrial gear that I like, it's a good play on multiple markets that I believe are due to recover. Twin Disc also offers a level of information available to investors that companies 10 times or 100 times larger often fail to offer.

The short-term question is timing - I am confident that fracking, off-highway vehicles, and marine markets will recover, but I'm not so confident about when. The longer-term question is one of margins and operating cash flow generation - if Twin Disc can't generate double-digit operating cash flow margins as a percentage of sales, it is hard to see how Twin Disc's probable streams of cash flow are undervalued today.

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Fracking Will Recover, But Can Twin Disc Achieve Better Margins?