Allison Transmission Holdings, Inc. (ALSN) Earnings Call Transcript & Summary

All right. Good morning, good afternoon, everybody tuning in from U.S. and from Europe. Welcome to the BofA Global Industrials Conference. To those of you that have already had some sessions this morning, I hope your day is going well so far. My name is Ross Gilardi. I am the senior U.S. machinery analyst. I'm very pleased to welcome Allison Transmission as the first company in my coverage to present at the even this year. Allison has been a diehard supporter of the BofA Global Industrials conference, I think, for 9 years running now. So we're always very, very happy to have them present and appreciate their support. And representing Allison, very fortunate to have, CEO, Dave Graziosi; and CFO, Fred Bohley. Gentlemen, I don't know if you want to say a few words or just go right -- overview or just go right into it.

Ross, I think we can jump in other than to thank you and the bank again for hosting this event. As you said, a number of years of running that we participated. We're happy to do that. And good afternoon and good morning to those joining us, and we can jump right in, if you like.

Okay. Sounds good. Maybe the logical place to start out is just with the truck market, in general, I mean the demand data that we get. Obviously, there's plenty of data out there to analyze, remains very robust, particularly in North America. And just wondering what kind of visibility you feel like you have at this point in the year with obviously still lot of other sort of uncertainties out there. And just really also are your OEM customers producing in high gear yet at this point? Or does it still feel like there are a lot of inefficiencies out there in the channel?

It's a good question. As we completed our fourth quarter call last month, the outlook at that stage, we certainly felt and talked to the strength of the North American market. I think that continues to be the case. I think to your point partnering upon a high gear, so to speak. Things are busy across the North America truck industry. I will tell you we're continuing to see lead times get extended now. So the book is, as we understand it, it's very firm going into at this point, second half for the OEMs, and it really does start to set up, I think, giving us a stronger start to 2022 at this point. But looking across the various subsegments of the market between medium duty, Class 8 Straight, they all continue to be strong. Having said that, as we mentioned last month, a number of issues behind the scenes that the industry is dealing with as others are in terms of component availability, raw material, some challenges at this point related to specific types of steel. Mills are running pretty extended lead times right now. So labor availability to the pandemic continues to be a bit of a challenge, although it seems to be improving logistics, our challenge as well in terms of access, port delays, et cetera. So where everybody is dealing with that, I think it's a reasonably level-playing field from that perspective. You combine that with the simultaneous increase in demand from other sectors, and it is definitely challenging the supply chain, of course, then you have stimulus kicking in, which we'll get to, I'm sure. And that's another aspect. It really hasn't been felt yet, obviously, but that pretends to be a very -- set up for a very strong, we believe, 2021, as our guidance implied. Inventories are low, that continues to be the feedback from dealers. So they're struggling, I think, to keep up with demand from that perspective. Orders, if slots are available, are going to fill end-user requirements at this point rather than stock truck, so that should provide some tailwind into the second half of the year in terms of restocking retail inventory levels, et cetera. But overall, certainly a strong setup for the year.

Is there anything that you're seeing right now in terms of the setup, maybe just for the next cycle, assuming we're in a brand-new cycle here that would suggest at this point, stronger for longer versus -- we've had kind of a number of different mini cycles, it feels like over the last 7 or 8 years. But any perspective on that yet?

Well, I think the -- if you look at the strength for us in terms of what we've seen already. And if you look at the quality of the order books, and it's unusual, as I'm sure you know, as you mentioned, prior cycles. Typically you see order books getting squeezed in the second half of the year to try to get them firm. So OEMs are forcing cancellation if the orders are soft versus firm. You've already seen that started taking place with cancellation fees, et cetera. So the book being firm would imply that it's going to be very tight through -- into the second half of the year, and that would set up for stronger-for-longer scenario, certainly going into '22, and then you have some emissions changes a little bit further out that may have an impact as well. So you could find yourself, we could find ourselves in a situation where it's a pretty firm market position to be in for the next few years for that matter.

Got you. Maybe switching to oil and gas a little bit. We'd love to get your perspective on what you're seeing in the past when you've seen the recovery, and in commodity prices, it's always seemed like you feel it first in the product support and parts business? Is that playing out yet? Or what's the rig count bouncing off the lowest?

Yes, the -- I would say, overall, with the off-highway market and what you're starting to see, and I mentioned issues with steel supply, you're seeing that in other areas. But I would say from a repair perspective, in terms of aftermarket, frankly, one of the biggest issues for the industry has been labor availability. Now that's being compounded with component shortages. So that sets up for a pretty firm aftermarket, I believe, situation for the balance of the year. The other thing is with budgets being refilled, if you will, or firmed up through stimulus and other methods, things that have been deferred relative to purchases or aftermarket should ultimately get funded. But the off-highway side in terms of energy, certainly starting to see more equipment utilization, and that will drive, we believe, some level of aftermarket utilization as well.

Got you. Dave, I'd love to get your perspective. I mean, to your credit, Allison did not resort to a lot of short-term cost-cutting measures last year in the midst of -- in the real depth of the pandemic, like a lot of other companies. I would think that would position you well for the next cycle that we're in. I'll assume you're going to agree with that, but feel free to comment and just wondering what the implications are for margins and returns this cycle?

Yes. I appreciate the recognition of, I think, our strategy in managing through the cycle, and I'll let Fred detail a bit more about what our approach was coming into this unfortunate with the pandemic and where we find ourselves currently.

Sure. Yes, Ross, as you mentioned, we didn't take any temporary reductions. We took some restructuring initiatives relative to hourly and salary headcount. As you know, over the cycles, we've really demonstrated some remarkable performance, really going back to the 2019 timeframe. Clearly, the business has a tremendous amount of operating leverage. The growth outside North America, India and our Hungary facilities, around 1 shift. So in fact, we can double that business without significant capital investment. We remain laser-focused on manufacturing efficiencies. As you know, historically, we've been able to gain price. Going back to the IPO, averaging about 50 to 75 basis points. And that's really by driving improvements in our products through innovation, adding more value to the end-users and being able to take share and also price. Certainly, mix will have a part going forward. In 2019, we bought the Walker die cast -- aluminum die cast business. Clearly, that doesn't have 50% gross margins, but it's certainly -- thinking about the supply chain challenges in 2020 very pleased with that acquisition. You mentioned earlier where we sit with off-highway, all of that in front of us that obviously has very attractive margins. Specifically for 2021, we talked about on the Q4 call, we do anticipate getting price, 50 to 75 basis points. There is -- with the challenges that the supply chain is having, meeting demand is higher than anticipated. There's some inefficiencies in the system. Dave touched on it, whether it be labor, freight. So we do expect to be closer to price cost neutral in 2021, while continuing to fund our engineering R&D.

Got it. Thanks, Fred. Dave, you alluded to the stimulus before. I did want to touch on that. How important is the latest round of stimulus that just passed in restoring confidence to the state and municipal markets? And can you remind us of your general exposure, how you would quantify it to state and muni spending, particularly in your North America On-Highway business?

Sure. The North America, I mean, typically over the cycle 30% to 40% of North America On-Highway revenue is in some way, shape or form tied to municipal. So market has been mixed through the pandemic for obvious reasons given the funding constraints because of funding that's been diverted to the pandemic. Having said that, that funding deferral also creates -- sets up, as I mentioned earlier, for, we believe, a firmer book going forward because the big issue is the spending is obviously critical there in terms of stimulus, but the big issue is removing restrictions about activity, right? Activity is going to drive utilization. They're not going to replace units unless they need to with the dramatic drop you've seen in transient utilization, that certainly sets up for some level of deferral. You could say the same thing in many cases about school buses. So having said that, stimulus start to backstop some of these budgets. And frankly, weather, this winter has been pretty extreme, has knocked out a couple of budgets. That backfill, I think, will be critical to start giving the municipalities the confidence to return to spending on repairs. But the big issue for us really gets back to removal of restrictions, and you're starting to see that. When that happens, you're going to see recovery in terms of, obviously, the restaurant and entertainment businesses, which has a whole another subsegment of the medium-duty market in terms of returning. So we see that stimulus touching a number of different subsegments beyond municipal, and we believe it's critical to get restrictions moving in the right direction and ultimately recovering in activity.

I'd love to just touch on one of the megatrends, which is obviously autonomy across autos and industrials right now. And just wondering how should we think about fully automatic transmissions? And what role they play in that evolution? And is that something, in particular, that could pick and drive your business in your key end-markets? And I'd love it if you could touch on both on-highway and off-highway there, too.

Sure. The -- your point on autonomous, and it really does get back to if you're going to provide that level of autonomy, and you're going to need control, a high level of control. The fully automatic transmission by design is a very highly controlled mechanism, right? So you think about how are you going to control a vehicle, both speed and movement. So no sudden movements, very controlled speed. That's impossible to do with the manual transmission and you'd argue even with automated solutions to get that level of control. So the fully automatic transmission, we believe, certainly has a key role to play in autonomy. And you're starting to see that in a number of locations. You mentioned off-highway specifically around mining, you see it in agriculture and other locations, but think about high levels of control, high-value vehicles. That's really core to Allison's value proposition. So we've done -- certainly have been undergoing some development work there with a number of different OEMs. I think last year, you saw, I think, late second half working with NHL in China on an autonomous mining vehicle, a relatively large vehicle, but you think about extreme conditions where you don't -- very hard to actually provide labor in those environments. The autonomous solution is a perfect solution ultimately for that, and we believe delivers a tremendous amount of value. So it's both on-highway and off-highways, as you mentioned, Ross, and certainly something we're continuing to push. Tremendous amount of interest in that particular segment right now. It's really a question of how quickly the broader infrastructure and ecosystem can take place to ultimately bring those solutions to the broader market.

Got it. Dave, I just had a question come in from the audience, and I'm not sure if you can comment or not, but does Allison play any role in the Oshkosh's recent victory with the U.S. Postal Service contract in the next-generation delivery vehicles?

No. We don't have -- that particular vehicle is what I would consider to be in terms of size an automotive platform, so relatively small and replacing a relatively small vehicle they're going for with has been a very long-term solution. The U.S. Postal Services going for there with interchangeable chassis bodies and -- but very small GVW.

Got it. I want to shift to capital allocation, always a hot topic with Allison Transmission. You've raised the dividend nicely over the last couple of years. I think you just raised it again fairly recently. And you're still buying back a lot of stock, even last year. I guess I'd love to get your perspective just on how your weighing returns to shareholders versus internal investment, the R&D is balanced higher this year? And I'm just wondering at all are we at the point where Allison is potentially going to start to invest more in the business to the extent it might visibly alter your capital allocation policy towards -- away from shareholder return towards internal investment?

Sure, Ross. This is Fred. Yes, as you mentioned, we did just raise the quarterly dividend from $0.17 to $0.19, so 12% in the first quarter. It's a balanced approach for us from a capital allocation standpoint. We're going to fund the organic revenue and earnings growth. We're going to fund new product and technology development. And that's really tied to the market opportunities. What you saw in 2020 is why we took restructuring activities. That was not at the expense of the engineering R&D. We continue to fund that. And obviously, we've got that funding up another 30% in 2021. After we fund the business, we'll pursue strategic acquisitions, but clearly we generate a significant amount of cash. In the middle of the global pandemic, we generated over $450 million in free cash flow. So we're going to return that cash to shareholders. We obviously got the dividend in place. There'll be opportunistic share repurchases. Thinking 2020, we repurchased 5% of our shares, so over $225 million in repurchases. And then really going back to the last 4 years, we repurchased about 1/3 of our shares. Definitely focused on prudent balance sheet management and maintain the low-cost flexible prepayable debt structure. We did the refinancing activity in the fourth quarter, extended out maturity towers. And we're able to take down a 5% bond and backfill it with 3.75 coupon. So it's a balanced approach. We're fortunate that we generate such a significant amount of cash that we can really hit all of our priorities. But back to the specifics on funding the business, it will be market opportunity driven. And as we sit here today, we're investing across all of our end-markets, conventional, EV, hybrid electric, and very excited about those investments and the opportunities they present.

Fred, you just mentioned acquisitions a bit and you got Walker die cast, and we're going to talk about AxleTech in a little bit, but what about a larger acquisition that's going to give you more immediate EV content with 1 or more [Audio Gap] that helps you guys continue to develop the narrative, which is obviously well underway and very, very active, but with respect to EV and so forth. I mean, is a larger acquisition, given that your leverage is down, is as low as, I think, as it's ever been, potentially on the table or most likely not. You kind of go more at the EV market organically than with what you've done with AxleTech?

You broke up a little bit mid-question. I think the question was around strategic acquisition opportunities and size? Okay.

Yes.

Yes. Yes, I think as we sit here right now, the lens that we look through for potential acquisitions. It's -- obviously, technology is one, something that's close to the end markets that we know, potential something with geographic to extend our reach. Having said all that, something that's more bolt-on in nature. And then specific to new technologies, there's a lot of ways to get there. Clearly, we can't do everything. We know that. But partnering doesn't necessarily mean that you have to do an outright acquisition.

Okay. I hope I'm coming through clearly now. If I'm not, I'm happy to repeat any of my questions. Maybe you can talk just a little bit more about your North America On-Highway business and market share and despite all the concerns on EV and the potential impact to your core business, I mean your market share has continued to trickle higher for the most part in your core markets for the last several years. And I'm just wondering how much longer do you think that can and will continue? What are you baking in to your guidance this year with respect to share across bus 6, 7 and in Class 8, it's straight? And could we start to see a little bit of market share give back in the next year or 2 as some of these EV releases with the major OEMs start to commercialize, at least in smaller quantities?

The North American market, Ross, as you know, as we've grown into position over the last few decades, we didn't arrive at this overnight. I think the share positions that we do have reflect the key point, which is manual transmissions going away in terms of the market because there aren't drivers for manuals, and you're continuing to see that reduction or degradation in the labor pool to be able to drive manually equipped vehicles. So there is still ground out there to be gained, I think to your point, and we see more of that have been very successful in recent years around gaining share in Class 8 Straight because of the value proposition that our solution delivers, I would say, overall. There is more -- we believe there is more there relative to what we assume for the guide this year relatively stable share with some pockets of gains. Having said that, as you look at how the markets developed so far, the first couple of months -- first several months of this year alone, it continues to be relatively busy and very strong segments for Allison. So we're staying close to those opportunities and spending time with end-users as we typically do in terms of some of our conquest activities, if you like to use that word. Overall, we're happy with that, but we would expect some level of gains this year. I think to your point on EV, to the extent that EV gained some traction in the market, which we believe it obviously will, we do think there's a number of growth opportunities to mitigate some of that potential share loss, if you think about it that way. Having said that, as you know, we also have EV solutions that were developing. So we think in a combination the future is still very bright for Allison. But we don't -- in terms of where we sit because of the high positions we have, as you indicated, very hard to envision significant share gains beyond what we have -- what we enjoy today, but it really gets back to, as I started with, what value proposition are we delivering to the end-users. And again, the product continues to perform better over the years, and our investments to like Fred's earlier comment we continue to invest to make even better products, and we're moving to our next generation of transmission controls as we speak, and that's an important aspect of enabling back to your question on things like autonomous and over-the-air programming, et cetera. We're making those investments and delivering those solutions. So the value prop continues to improve. At the same time, we're always looking to grow our share, and you'll see some of that in terms of some of the EV development that we have been working on as well.

Dave, with your positive -- stable to positive share outlook for -- you just alluded to across your businesses, would that include school bus because there just seems to be a lot of announcements in school bus in particular?

There are in terms of -- to your point, in terms of alternative or EV in school bus, the challenge right now with school buses -- the industry is expecting a relatively soft year. And I think we talked about that a bit last month. But as you think about where it is, to my earlier comment, in many cases, as you well know, school districts have not been using -- have not had in-person classes or have really reduced students needing transportation because they don't want to put them in that situation so they are getting alternate ways to get to school. The fleets have been really underutilized. So we expect a relatively soft year, but I think you will continue to see the industry end-users push for some level of alternate fuels, and I think, EV certainly has a place in bus. That also, though, comes back to the total cost of ownership and how those individual districts are going to be able to manage the infrastructure as well.

Got it. How about AxleTech? I want to give you an opportunity to speak about that and where you're going with some of it?

Sure. It's about 2 years now. We have executed the AxleTech acquisition in April of 2019. Very happy with that acquisition in terms of the architecture, the IP that we acquired as well as a very talented group of engineers and other professionals. And I think the -- to date, we've done a lot of work with that team to further refine the design and ultimately get what we believe is a differentiated solution. So we're pleased. That operation also now includes a 100,000 square foot plus facility in Michigan to house that team as well as the axle production. So we've continued to make the investments and develop that -- further develop that solution, but we're pleased with where we are at the same time, not settling for what we initially acquired in terms of the IP, but expanding the IP around a broader set of solutions, which will allow us to fill a number of different potential vocations with base gearbox and motor if you will. So we're -- the team is spending the time coming up with essentially a single solution with some -- that will need some level of variation, but be able to cover a broader portion of the market and ultimately expand our addressable market, but we're pleased 2 years in with what we have.

Just had a question from the audience on how much of the increased R&D effort is focused on EV versus enhancements to your core automatic transmission offering? And when can we expect to hear more information possibly in the form of an EV Investor Day from Allison?

Well, to start with the 3 years ending with 2020 through acquisitions and R&D spending, specifically targeted at EV is $0.25 billion already. So this year, if you look at our increase year-over-year in terms of R&D spending, a meaningful portion of that is actually focused on electrification, electrified solutions, both the e-axle as well as a number of other solutions as well as our hybrid transit bus product that's moving to a next-generation platform. The work that we're doing continues to -- with a number of OEMs, as we've talked about large OEMs that represent a significant portion of our North America business continues. So we're pleased with that and certainly expect a number of additional developments to be announced as we get further into the year. I would say one of the things that we are certainly seeing is all of the things that we mentioned in terms of conventional having an impact whether that be labor availability, the timing of securing components, et cetera, is all impacting electrification programs. So those are not distinct issues, frankly, and we're seeing some of that in terms of efforts with various parties on both conventional and electrified vehicles in terms of executing programs both on time as well as scope. So -- and that's something that I think we should be proving in terms of the second half of the year as we get some of these restrictions. You can only do so much virtually, and we're finding there's a number of limitations there that we expect to overcome in the second half with restrictions being removed.

Is it realistic to expect a more formalized collaboration with -- on EV between Allison and one of the major truck OEMs on a big platform sometime over the next 6 to 12 months?

I think it's a very reasonable expectations. And we're thinking about it, just to be clear, not only from a North America perspective, but global OEMs as well. So with efforts in terms of whether it's Europe or even Asia at this point. So it's not just North America that's a large and important market, but we're thinking globally at this point in terms of our OEM relationships and a number of different vocations that we know very well from a conventional perspective, but applying that knowledge in specific application of electrified vehicles, electrified solutions for those locations. And those are challenging at times. So you have to think about all of that, but it's more of an all proposition for us, but we will do it the right way, the Allison way, which is deliver the brand promise, but deliver solutions that frankly meet or exceed conventional expectations, which are pretty high given our performance levels over the year as you know.

What are the next milestones to look for, for Hino? And maybe you could just talk a little bit about Hino? Because I don't think there is well-known in the U.S. market, and there was announcement of collaboration between Hino, and Cummins announced yesterday, and Allison is playing a role in that as well, if you could address that.

Sure. Hino, obviously, a valued customer of Allison over many years, and I think that, that team has really done a remarkable job with their platforms, both for conventional as well as thinking about electrification in terms of solutions. As you could tell from that announcement, I think they're very similar in approach in terms of what some of the other OEMs are thinking about, which is what is next in terms of conventional and that being one question that needs to be answered, as they're trying to deal with the electrification question. And I think the team Hino has been very engaged on both fronts in terms of addressing their conventional portfolio and at the same time looking at electrified solutions. But we're pleased with where that engagement has taken us so far in terms of development. They're very high-quality OEM, very capable, but very focused on ultimately development and validation to a level of performance that we certainly plan on meeting or exceeding. That being said, we'll let Hino run through their courses as we do with all our customers. We're not going to get ahead of them, but I think these announcements that you're starting to see in terms of conventional decisions ultimately provide the opportunities to start solidifying or taking those next steps in terms of electrification.

What are the next milestones to look for with Hino, do you think? And I believe you guys are -- you're being tested on that as Class 7. Is that correct? And like, is there a potential that you would have a broader role across the -- their zero-emission series in other vehicles as well? Or is it really sort of a very specific to the Class 7?

Well, it's really -- I would say, Class 7 as well as the lower end of 8 in terms of what that platform looks like. It's a -- we view it as a very competitive vehicle platform. The work that has been done, we've certainly been impressed with the results, that team in terms of milestones. It's really the broader application that you just referenced is what we're working on now is where does that ultimate solution go to in terms of their portfolio. So I believe they are working on a number of different portfolio decisions in terms of different solutions. So we're, again, pleased with where we are from a milestone perspective. Again, we'll let Hino take course in terms of their timing on decisions. But the big issue, our focus is, again, delivering an electrified solution or solutions that meet or exceed conventional expectations, which are again very high. But we're pleased with where we are with Hino.

How's your e-axle offering different than Meritor and Dana? Is that who you consider to be your primary competition?

There's a -- obviously, both high-quality companies, very capable teams, but they're not the only e-axle providers in the world. I mean, I think we tend to, at least from a North American perspective, focus on a limited number of suppliers. But globally, there are tremendous amount of e-axle solutions that are out there. So I would say we look at all of them in terms of competition. I would -- in terms of how we think about how investors should think about the Allison solution, it's certainly, again, amongst a number of different solutions that are out there, but I would say the level of engineering and development and integration of our e-axle is really what differentiates our solution. The fact is you could look at many of the e-axle solutions that are available or even being developed at this point that are relatively basic in terms of their development. And what I mean by that is you're essentially taking conventional components and attaching some level of electrification to it, but it's not an integrated solution, if that's clear. So our solution is fully integrated. So back to my earlier comment in terms of a base solution with the gearbox and motor, that's completely integrated in terms of the Allison solution. We then can create variance off of that to move to cover a number of different classes of vehicle or GVW. So as you think about applications, that's important versus having numerous different e-axle solutions, which others really are providing at this point in terms of relatively basic solutions, but the proliferation that, that requires is high. And that's, as you well know, covering the space as long as you have, not something that vehicle manufacturers favor is proliferation. So we do think a solution that can be applied across a number of different locations and vehicle classes is preferred, especially when you look at the performance gains of an integrated solution versus nonintegrated.

The feedback we get from some OEMs is that Allison generally wants to sell its parts directly to the customer and cut out the middleman, that being the truck OEM potentially who wants to resell your parts. And therefore, the OEM can't resell an Allison parts to service its field population. Can you comment on that? I mean is that generally true? And if so, has that -- do you feel like that's cost you -- that approach has cost you any particular growth opportunities?

Why, when you say we want to sell our parts directly to the end customer and cut out the middleman, what we're really focused on there is aftermarket right is repair, repair parts. And understanding OEMs are very focused on capturing as much of the value chain as they can, I think your comment in that their comments is probably accurate. Having said that, I would certainly argue a number of things. When we focus on selling our aftermarket, it's really sold through our independently owned and operated channel or dealer network, both distributors as well as dealers, all of which are authorized to service our products. Why that's important is that's not a low-cost solution to maintain on behalf of our channel partners. Dealers certainly are free to join the Allison network, but it does require investment. And as with many things, you can pick and choose as to what your outcomes are. But if the outcome is, I just want to sell parts, there's going to be an investment that's required, that becomes a barrier. Frankly, we -- what we're concerned about as Allison is the end-user experience. And they drive, frankly, the bulk of the demand for our products, right? That's how we gain share is working directly with end-users. So we view that opportunity with our channel is just that, which is the opportunity to deliver our brand promise, and we hold our dealers and distributors to a high level of performance, but also provide the opportunity for Allison and that channel to work directly with end-users. So I certainly appreciate the comment and the point. But I would argue, I think if you talk to our end-users, they're pleased with the service that they ultimately receive and the value that the product delivers. And ultimately for us, it really becomes another driver for growth.

Got it. Well, good. Well, look, I think our time is just about up. I know everybody's got a busy day, but a great rundown. Dave and Fred, always appreciate your support of our industrials conference every year. Even though it's virtual, it's more fun being live in London, but thank you for being here today. Hope you have a productive day with all your meetings. And everybody, thanks for joining us for the session.

Likewise, Ross. And again, thank you to you and your team for hosting us once again and hopefully look forward next year to being in person, so -- in that opportunity.

All right. Sounds great, guys. Have a great day.

Thanks. You, too.

Thanks.