This Transmissions Company Is Likely To Offer Better Returns Over Caterpillar Stock

by Trefis Team
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We think that Allison Transmission Holdings stock (NYSE: ALSN), a relatively small company that manufactures commercial duty automatic transmissions and hybrid propulsion systems with a market cap of under $4 billion, currently is a better pick compared to its industry peer Caterpillar stock (NYSE: CAT), given its lower valuation. Allison trades at about 1.6x trailing revenues, compared to 2.3x for Caterpillar.

Both the stocks have underperformed with -20% returns for ALSN stock and 6% gains for CAT stock year-to-date, compared to 22% growth for the broader S&P 500. Caterpillar saw a fall in demand for its equipment, primarily for construction use, during the pandemic, but recovered sharply over the last twelve months. Allison’s defense business, although small in size (<10% of total sales), expanded 21% even during the pandemic, partly offsetting the declines from other segments. While both the companies saw around 22% plunge in sales during the pandemic, the recovery in sales has been better for Caterpillar.

However, there is more to the comparison. Let’s step back to look at the fuller picture of the relative valuation of the two companies by looking at historical revenue growth as well as operating margin growth. Our dashboard Caterpillar vs Allison Transmission HoldingsIndustry Peers; Which Stock Is A Better Bet? has more details on this. Parts of the analysis are summarized below.

1. Comparing Revenue Growth of Caterpillar And Allison

  • Caterpillar’s revenue growth of 25% over the last quarter was much higher than 6% growth for Allison, led by strong 30% growth in construction equipment revenues, driven by a rebound in non-residential construction demand.
  • Allison’s revenue growth was adversely impacted by supply chain issues, labor, and raw materials constraints that have weighed on the overall commercial vehicle supply.
  • Looking at an even longer time frame, Caterpillar’s last three-year revenue CAGR of -1.2% is the same as for Allison.
  • Looking forward, Allison is expected to see slightly better revenue growth of 17%, vs. 15% for Caterpillar, going by the companies’ historical growth pattern.
  • With economies now opening up, the demand for industrial equipment as well as commercial vehicles is likely to remain high in the near term, boding well for revenue growth of both the companies. Our Caterpillar Revenues dashboard provides more insight on the company’s revenues.

2. Allison Is More Profitable

  • Allison’s operating margin of 22% over the last twelve month period is much better than the 13% for Caterpillar, and it compares with 28% and 15% figures in 2019, before the pandemic, respectively.
  • However, if we were to look at the last three-year change in operating margin, Caterpillar’s 20 bps fall is better than a 370 bps decline for Allison.
  • Overall, Allison’s operating margin has historically been better than Caterpillar, and this trend will likely continue going forward as well. Our Caterpillar Operating Income Comparison and Allison Transmission Holdings Operating Income Comparison provides more details on the margins.

3. The Net of It All

Now that nearly 60% of the U.S. population is fully vaccinated against Covid-19, with overall economic activity picking up, the demand for construction as well other industrial equipment is likely to rise going forward, boding well for Caterpillar. For Allison, a broader shift to low emission vehicles is likely to pave the way for continued growth for the company, given its product-line, including eGEN Flex, which is a zero-emission electric hybrid propulsion system.

That said, Covid-19 is proving more difficult to contain than initially thought, due to the spread of more contagious virus variants and infections in some of the geographies, including Europe, are higher than what they were a few months back. The concerns around Omicron has spooked the markets at large with one confirmed case in the U.S., as well. If there is another large spike in Covid-19 cases from the new variant, it will disrupt economic recovery and impact sales as well as earnings growth of companies.  This may result in pressure on margins in the near term for both the companies.

  • Not only is the current valuation of Allison a little more attractive than that of Caterpillar, with ALSN stock trading at about 1.6x trailing revenues, versus 2.3x for CAT stock, Allison offers superior operating margins.
  • However, if we were to look at financial risk, Caterpillar’s debt as a percentage of its equity is lower at 3% vs. 69% for Allison. Also, Caterpillar’s 12% cash as percentage of assets is far better than the 6% figure for Allison, implying that Allison has higher financial risk compared to Caterpillar.
  • Overall, Allison’s superior profitability and better revenue growth prospects, albeit at a higher risk, make it a better pick between the two.
  • Looking forward, it is likely that the gap in valuation of these two companies will narrow in favor of the more attractive stock – ALSN, in our view.
  • The table below summarizes our revenue and return expectation for CAT and ALSN over the next three years, and points to an expected return of 65% for ALSN over this period vs. 39% for CAT. Our dashboard Caterpillar vs Allison Transmission Holdings has more details on how we arrive at these numbers.

While ALSN stock may see higher levels, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Allison Transmission vs. Atlas Air.

 

Wondering how Caterpillar peers stack up? Check out Caterpillar Stock Comparison With Peers to see how CAT stock compares against peers on metrics that matter. You can find more such useful comparisons on Peer Comparisons.

 

What if you’re looking for a more balanced portfolio instead? Here’s a high-quality portfolio that’s beaten the market consistently since the end of 2016.

Returns Dec 2021
MTD [1]
2021
YTD [1]
2017-21
Total [2]
CAT Return -7% 6% 108%
ALSN Return 6% -17% 6%
S&P 500 Return -1% 22% 104%
Trefis MS Portfolio Return -1% 43% 290%

[1] Month-to-date and year-to-date as of 12/2/2021
[2] Cumulative total returns since 2017

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