Allison Earnings: Demand for Medium-Duty Trucks Is Strong; Shares Trade at an Attractive Valuation

Allison ALSN reported solid third-quarter earnings, thanks to strong demand for the company’s transmissions in medium-duty and vocational trucks. Consolidated sales were up nearly 4% year on year, largely due to strength in Allison’s North America on-highway (up over 10%), defense (up nearly 23%), and services (up almost 9%) businesses.

The global off-highway business (down 53% on a combined basis) performed poorly in the quarter, which was a surprise. In North America off-highway, recent M&A activity has led players in the energy market to pause and reassess fleet sizes and capital investments. Outside North America, off-highway was negatively affected by the timing of mining OEM orders according to management. Allison expects the fourth quarter to look better than the third quarter. That said, management reaffirmed its 2023 guidance. This gives us confidence that the company can grow sales by over 8% this year (versus our previous estimate of 9% growth).

We elected to leave our $74 fair value unchanged. Our lower near-term sales expectation for the global off-highway business offsets the time value of money since our last update.

Setting aside the revenue declines in off-highway, we were pleased with Allison’s strong profitability performance. Gross margin increased 230 basis points in the quarter, largely due to stronger pricing. This dynamic led us to lower our 2023 operating margin estimate by only 10 basis points to 29.7%, following the global off-highway update.

Turning to valuation, we see about 23% upside in the stock compared with our fair value estimate. The broader truck market is cooling, but we find comfort in Allison’s high exposure to medium-duty and vocational trucks. We believe these verticals will benefit from replacement demand, given the high average fleet ages. Furthermore, Allison’s exposure to municipal spending should help reduce cyclicality. Municipalities account for 30%-40% of the company’s North America on-highway volume.