Allison Transmission Holdings, Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Allison Transmission Holdings is a global manufacturer of automatic transmissions and propulsion solutions, primarily for commercial vehicles.

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.

Allison Transmission (ALSN) is a unique company that benefits from specialized markets and long-term contracts but faces several risks. While not having a truly wide moat, its strategic position and robust finances still make it a noteworthy business.

Business Overview

Allison Transmission Holdings, Inc. (“Allison”) designs and manufactures commercial and defense automatic transmissions and hybrid propulsion systems. Founded in 1915, it’s a global leader in its niche, with significant operations in North America, Asia, Europe, South America, and Africa. Approximately 75% of their 2022 revenues were generated in North America.

  • End Markets: The company serves diverse sectors, including:
    • On-highway vehicles (e.g., trucks, buses, and motorhomes)
    • Off-highway vehicles (e.g., construction, mining, and energy equipment)
    • Defense vehicles
  • Product Offerings: ALSN provides a range of fully automatic transmissions designed for medium- and heavy-duty vehicles, including:
    • On-Highway: 1000 Series, 2000 Series, 3000 Series, 4000 Series, eGen Flex Propulsion Solutions
    • Off-Highway: 3000 Series, 6000 Series, 8000 Series, 9000 Series, and a variety of other niche products such as articulated dump trucks.
    • Defense Various platforms, including wheeled and tracked combat vehicles.
  • Manufacturing: They have manufacturing facilities in the United States, Hungary, and India, allowing them a global reach while being cost-competitive.
  • Distribution: ALSN distributes products through an independent network of approximately 1,400 independent distributors and dealers.

Moat Analysis: 3 / 5

While Allison doesn’t boast a wide moat, its economic advantages are strong enough to provide a competitive edge. Here’s a breakdown of the factors contributing to a “narrow moat” rating:

  1. Switching Costs: The high switching costs associated with specialized vehicles play a vital role in Alsn’s narrow moat.
    • OEM Relationships: Allison works closely with its original equipment manufacturer (OEM) customers, often designing specialized transmissions for specific vehicle models. This creates a reliance on Allison as a primary supplier. * Long-term Contracts: ALSN benefits from long-term contracts with the U.S. Department of Defense and other government buyers.
    • Integration: Many vehicles use transmissions that are closely integrated with the engine and computer systems of the vehicle, which means that switching to a competitor would be incredibly complicated.
  2. Brand Recognition & Reputation: ALSN has a reputation for producing high-quality, durable, and reliable transmissions and is known for being on the cutting edge of technology in automatic transmissions. This brand helps build and sustain relationships with many long-term customers.
  3. Scale Based Advantages: ALSN is one of the few large-scale manufacturers of specialized transmissions, and can gain a cost advantage by spreading its fixed costs over larger production volumes, while having global scale. However, it is limited by industry specifics and doesn’t grant the company a wide moat.
  4. Regulatory Approvals: Allison obtains certifications from regulatory agencies worldwide that allow its products to be used in specific vehicles.

Risks to the Moat and Business Resilience

While the moat is somewhat present, there are several legitimate risks that could weaken or erode it:

  • Technological Change: Emerging new technologies and increased competition from other manufacturers that may lead to loss of market share is a big risk.
    • Evolving Propulsion Systems: Companies are increasing spending on developing electric and fuel-cell vehicle and propulsion system. If competitors gain a significant lead in the development and manufacturing of these systems, their competitive advantages can reduce.
    • Autonomous Driving: Any increase in automation will make older generation transmission systems obsolete, and the newer entrants could have an advantage.

  • Economic Sensitivity: The company’s revenue is highly correlated with the commercial vehicle market. Any recession can lead to decreased demand for their products.

  • Intense Competition: Many other companies have tried and succeeded at offering similar products to ALSN.

  • Supply Chain Issues: ALSN relies on a complex supply chain and any issues with suppliers could lead to decreased profitability, and higher prices.

  • Dependence on OEM: Since most of ALSN’s product development depends on integration with customer’s designs, loss of relations with the largest OEMs could greatly affect the business.

  • Customer Concentration: Sales are concentrated in a few key customers, which may lead to a difficult negotiation environment.

Despite the risks, the company shows resilience due to:

  • Long-term Contracts: The company has some very strong and long-term contracts that are difficult for competitors to win over, and the stability of these contracts is a good protection from competition.
  • Established Customer Base: Its long relationships with large manufacturers across the globe, it makes its customers hard to move to another company, because they will have to retool a new design.
  • Diversification: Though it still relies primarily on North America On-Highway revenue, its new markets in Asia and the Middle East may help mitigate downturns.
  • High Returns on Capital: A good average return on invested capital, as stated above.

Financial Analysis

  • Revenue Distribution: In 2022, approximately 75% of ALSN’s revenues came from North America, while Asia, Europe, South America, and Africa accounted for the remainder. The On-Highway segment dominates but Off-Highway and Defense are also important.
  • Historical Sales and Growth:
    • 2021 total net sales came at 2.4 billion, while in 2022 the sales increased to 2.7 billion, a 12% increase.
  • For the six months ended September 30, 2023 the total net sales were 1.9 billion, while the total net sales for the same period in 2022 were 2.1 billion. a 10.4% decrease.
  • The main driver of increased revenue in 2022 were higher prices for their products, in addition to increased volumes for on-highway products in North America. Decreases in the first half of 2023 were driven primarily by a decrease in OEM volumes.

The company is expecting a slowdown in the third and fourth quarters of 2023 which will be a drag to their results and make their yearly result less than what they have seen in 2022.

  • Margins: ALSN has high gross margins (40%+) and EBITDA margins. A large portion of their expenses are allocated to engineering and research and development, which allow for continued innovation and product development.
  • Financial Health: A quick analysis of the balance sheet shows:
    • ALSN is free cash flow positive
    • It has an average of 1.9 billion in assets compared to 1 billion in liabilities as of September 30, 2023.
    • They have plenty of cash on hand ($991 million), however they also have significant amounts of debt ($2.5 billion) that might affect the company’s performance if they need to take up any further debt.

As a whole the financial health is very strong and they are able to weather harsh economic conditions.

Understandability: 2 / 5

While Allison’s business model is relatively straightforward (designing and selling transmissions), the detailed mechanics of their manufacturing process and industry specifics make it somewhat complicated for an average investor to fully grasp. Understanding the long-term contracts and engineering aspects will be challenging for some people, which is why the understandability is only at “2”.

Balance Sheet Health: 4 / 5

The company has a strong balance sheet and plenty of cash to cover short term liabilities. However the company holds significant amounts of debt, which means we can rate them a 4 out of 5 for their financial health. The main reason they get a 4 instead of a 5 is that a company that holds a significant amount of debt is always a higher risk.

Recent Concerns/Controversies

  • Supply Chain Issues: The company has experienced disruptions in its supply chain and increased raw materials and component costs. This is something that is happening across all different companies, and management believes that it will be resolved in the coming years. They are actively looking for ways to alleviate costs.
  • Lowering Revenues: Allison has been guiding lower sales estimates for the future as volumes in truck manufacturers and other clients have been reducing. Although management believes that it will pick up again in 2024, they are wary of what might happen.

Final thoughts

Overall, Allison Transmission is a well-positioned company, with some form of economic moat and a good understanding of its industry and client base. However, there are major forces at play that could disrupt and harm their performance, which should be kept in mind when investing in this stock.