Rising Costs And Lower Volumes Will Undercut On-Highway Performance

Key Takeaways

• North American market growth is slowing, with manufacturing and commodity costs pressuring margins and impacting revenue expectations.
  
• Limited growth in international markets and increased capital expenditures may constrain earnings and hinder diversification potential.
  
• Strategic investments and defense sector expansions position Allison Transmission for continued revenue and earnings growth amid strong market demand and infrastructure spending.

Catalysts

Designs, manufactures, and sells fully automatic transmissions for medium- and heavy-duty commercial vehicles and medium- and heavy-tactical U.S.

• Allison Transmission's growth in the North America On-Highway market is expected to slow to only 1% in 2025, driven by decreased volume in the medium-duty segment, which may negatively impact revenue expectations given previous years' higher growth rates.
  
• Despite achieving record sales, manufacturing expenses and commodity costs are exerting pressure, with raw material costs partially offsetting price increases. This could compress gross margins and impact net margins adversely.
  
• The expectation of flat revenue growth in the Outside North America On-Highway market due to fewer commercial vehicles and regulatory-driven pull-ahead sales in 2024 indicates limited revenue growth potential compared to prior successful years.
  
• Adjusted free cash flow is projected to be lower in 2025 due to higher capital expenditures and operating challenges, constraining available capital for dividends and repurchase programs, which may lead to stagnant or declining earnings per share.
  
• Increased reliance on existing successful markets like vocational and defense amid broader vehicle market uncertainties may hinder diversification and future revenue growth if geopolitical or economic conditions change unfavorably.

Allison Transmission Holdings Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Allison Transmission Holdings compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Allison Transmission Holdings's revenue will decrease by 1.5% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 22.7% today to 20.9% in 3 years time.
• The bearish analysts expect earnings to reach $642.8 million (and earnings per share of $9.4) by about April 2028, down from $731.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 13.0x on those 2028 earnings, up from 10.8x today. This future PE is lower than the current PE for the US Machinery industry at 21.3x.
• Analysts expect the number of shares outstanding to decline by 2.24% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.74%, as per the Simply Wall St company report.

Allison Transmission Holdings Future Earnings Per Share Growth

Risks

• Allison Transmission achieved record net sales of $3.2 billion in 2024, driven by strong demand in the North America on-highway market and an increase in defense and international sales, suggesting continued revenue growth potential.
  
• Allison's investment in operations and supply chain enhancements, particularly for the 3000 and 4000 Series, expects to capitalize further on U.S. infrastructure spending, potentially bolstering revenue and margins.
  
• The company increased its full-year earnings per share to a record $8.31, up 12% from 2023, indicating a solid ability to grow earnings even in mixed market conditions.
  
• Allison's guidance for 2025 expects to continue realizing revenue growth into a range between $3.2 billion and $3.3 billion with significant contribution from price increases, positively impacting revenue and margins.
  
• Expansion of product offerings in the defense sector and a new agreement to provide transmissions for the Abrams main battle tank could drive further revenue and bolster earnings, given the ongoing geopolitical uncertainties.

Valuation

• The assumed bearish price target for Allison Transmission Holdings is $84.49, which represents one standard deviation below the consensus price target of $99.1. This valuation is based on what can be assumed as the expectations of Allison Transmission Holdings's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $126.0, and the most bearish reporting a price target of just $74.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $3.1 billion, earnings will come to $642.8 million, and it would be trading on a PE ratio of 13.0x, assuming you use a discount rate of 7.7%.
• Given the current share price of $92.24, the bearish analyst price target of $84.49 is 9.2% lower. The relatively low difference between the current share price and the analyst bearish price target indicates that the bearish analysts believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.