Allegion plc

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 4/5

A global provider of security products and solutions, primarily known for locks, doors, and related access control systems, offering both electronic and mechanical security options.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Allegion operates in the security solutions industry, a sector that benefits from several key trends. Their products and services are essential in both new construction and retrofitting existing infrastructure, driven by safety and security concerns of the end users. As a result, the company’s revenues have shown consistent growth in recent periods. The company is structured into three main segments: Allegion Americas, Allegion International, and Allegion Global Security Solutions. Let’s look at the details.

Business Overview

Allegion’s revenue is distributed across three reportable segments:

Allegion Americas: This segment contributes most to the total revenue, offering products for commercial, institutional, and residential properties in North America.
Allegion International: This segment serves commercial and residential markets in Europe, Asia, and the Middle East.
Allegion Global Security Solutions (GSS): This is a newer segment and the primary driver behind product innovation, serving customers across the world with specialized integrated access control and workforce productivity solutions, in recent years, it was reorganized as a separate segment.

Over 99% of Allegion’s revenues come from the sale of products, which are hardware, software, and other components, and the rest from services. They sell primarily to distributors and retailers, but also directly to end customers such as building developers.

The company is operating in a fragmented industry with many small players and fewer big players. The main areas of competition are based on products, services, prices, and distribution network.

Products: Many different players compete by trying to offer the best features to customers, including new tech advancements such as keyless access, electronic door hardware and cloud-based solutions for access management.
Services: These have been becoming an area of interest, especially for companies that can provide consultation services and integrated solutions which helps them to gain pricing power.
Prices: As the products are not fully differentiated or that specialized, price remains a primary factor, especially for big institutional customers.
Distribution Networks: Companies that have the most developed distribution networks (more locations) are better suited and have competitive advantage over their competition as long as other parameters are also met.

Financials In-depth

Revenue Growth: The latest results for the nine months ended September 2023 shows revenue growth across all their segments.
- Allegion Americas showed a growth of 13.1% as the pricing action and a strong demand were beneficial.
- Allegion International reported a growth of 9.1%, driven by strength in the global markets.
- Allegion Global Security Solutions saw revenue growth of a staggering 40.5% driven by robust demand and strategic acquisitions.

In FY2022, net revenues increased by 14.6% to $3.0B. The year ended with a total profit of $322.6 million, the total revenue was $2,760.6 million. The increased revenue was caused by price increases and strong demand. Net loss for 2022 was $46.2 million, largely due to one-time restructuring expenses and high acquisition costs.

Margins: Gross margins have remained quite steady, sitting at around 49%. However, this was offset by inflation and higher labor costs, which impacted overall profitability. However, as they have implemented new price increases, management is projecting that their operating margins will see some improvements in the coming quarters.
Free Cash Flow: Free cash flow was around $160 million for the latest quarter. The company intends to improve its operating efficiency, cut costs and improve its growth rate so they can use the generated cash to grow through both acquisitions and R&D, along with returning it to the shareholders through dividends and buybacks.
Debt and Leverage: Allegion’s debt to adjusted EBITDA ratio was ~ 3.1 at the end of Q3 2023, according to their latest earnings call. While there has been some increase in debt related to their acquisitions, the overall leverage is still kept at a manageable level.
- In the latest report, the revolving credit facility is also detailed. It shows that this facility includes $1.725B in funding for general purposes. The rate on that is 1-month term SOFR plus 1.0% to 1.4%. They also have several different senior notes in addition to the credit facility, the details are in the report.
- Most of their debt is fixed rate and thus not sensitive to market changes. The maturity profile of their debt is also stretched out, with majority maturing after 2026.

The financial health is not entirely flawless. In late 2022 the firm had a net loss for the year. Although their financials were negatively affected by interest rate increases and rising costs, management believes they will be able to increase profitability and margins.

They noted in their latest conference call that demand remains strong in the markets and the price increases are sticking, resulting in improved financials overall.

Economic Moat Rating: 3/5

Based on the analysis, Allegion has a Narrow Moat. Here’s the reasoning:

Brand Recognition: The company has an established name and is trusted by its customers, leading to repeat business and pricing power for the higher end products.
Switching Costs: While not high, switching costs do exist, given the need for seamless integration for large enterprise customers.
Distribution Networks: Company has extensive and specialized distribution networks which gives them an advantage over their competition.
Intangible Assets: They have valuable patents and technological know-how in product innovation as the company’s newer products include more technology and software.
Scale-Based Advantages: Although they don’t have big economies of scale (because the manufacturing of products is relatively easy for competitors to replicate), they do have a distribution advantage because of their geographical coverage.
Regulations and Certifications: Though not a moat in the traditional sense, they have all required certifications in the highly regulated industries they are operating in. This reduces the chances of newer players and gives advantages to incumbents.

However, the moat is narrow for the following reasons:

Product Differentiation: Although the products have certain differentiation, these are not very specialized, and can easily be replicated with competitors.
Pricing Power: Even though it is a key aspect for their business, the companies can only achieve higher pricing power by creating a superior brand. At the moment there are no clearly differentiated prices between the company and its peers.
Industry Competition: There is a lot of competition in the market and even though they have scale advantages in some areas, there are still smaller players and that can take some portion of their market share.

Business Understandability Rating: 4/5

The business model is relatively easy to understand.

The company sells security solutions, which are broadly categorized into mechanical and electronic segments. These are essential requirements of most commercial, institutional, and residential properties.
The revenue is mostly generated through the sale of products with some through services.
The drivers of revenue such as housing starts, replacement cycles, and infrastructure spending are relatively straightforward.
The company’s financials show consistent trends, although with some complexities related to their acquisitions and restructuring strategies.
- However, a few areas of the business may be difficult to follow and understand, such as derivatives and other noncore revenue streams.

Balance Sheet Health Rating: 4/5

Based on key metrics, the company has a strong but not perfect balance sheet.

Debt Levels: As mentioned above, they have a substantial debt load related to the acquisitions. But this debt is stretched across time with reasonable average interest rate which gives them leeway.
Liquidity: The company does have access to revolving credit facilities which means they are able to tap into credit if needed.
Cash Flows: They have positive operating cash flow for the past years.
- However, they are dependent on a stable economy to generate more revenue and use this cash to invest in their business, R&D, and return some of it to shareholders.

Legitimate Risks that Could Harm the Moat:

Technological Disruption: Rapid advancements in technology may render their existing products obsolete and lead to new innovative products taking market share. For example, newer startups coming with cheaper and better innovative products may challenge the pricing power that the company has created.
Supply Chain and Raw Material Costs: Being a hardware-focused company, they are dependent on a few select suppliers and they have to work with material costs. Any big disruptions in the supply chain or a sharp increase in the raw material costs may affect the profitability of the company.
Economic Downturn: They have a global presence with many different types of clients. Any general economic downturn, specially affecting the construction industry or residential sector, could affect their business and earnings.
Acquisition Risks: They rely on acquisitions to enhance growth, but failure to integrate acquisitions properly and manage their debt can lead to financial instability and loss of value.
Increased Competition: If more companies figure out their way into the industry, that could lead to pricing wars and decrease in their margins.