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Morningstar | Allegion Posts Solid 2Q Organic Revenue Growth; Excluding Acquisitions, Margins Stable

Allegion's second-quarter results beat consensus revenue and EPS estimates as the wide-moat-rated security products company realized strong revenue growth in North America and did a great job offsetting input cost inflation with pricing and cost reduction actions. Consolidated reported revenue grew 12% year over year to $705 million, which was about 1% higher than the consensus revenue estimate. Organic revenue growth was a solid 5%. While consolidated adjusted operating margin contracted 50 basis points, to 21.3%, this decline was due to the dilutive effect of acquisitions. However, acquisitions were accretive to adjusted EPS, which increased 13% to $1.25, beating the consensus estimate by $0.06. We didn't make any material changes to our key valuation assumptions, and we're therefore maintaining our $91 fair value estimate.

The most profitable Americas segment posted the strongest growth. Americas revenue grew 12% on a reported basis and 7% organically. Nonresidential revenue grew high-single digits and residential revenue grew in the mid-single digits. Nonresidential products generally carry higher margins than residential products. The growing popularity of electronic products, which we believe is a secular growth driver for Allegion, continues to support the firm's top line growth. Indeed, sales of electronic products grew in the high teens in North America. Americas' operating margin contracted 70 basis points to 29.6%, but excluding the effect of acquisitions, the segment's operating margin expanded 20 basis points to 30.5%. The Europe, Middle East, India, and Africa segment reported 14% revenue growth (just over 1% organic growth) and adjusted operating margin expanded 120 basis points to 8.2%. The Asia-Pacific segment reported 3% revenue growth (flat organically) and adjusted operating margin fell 520 basis points to 2.7%. Allegion is restructuring this segment, which should begin showing favorable results in the second half of 2018.

During July, Allegion completed the acquisitions of GWA Door and Access Systems and Isonas. The GWA deal, which was valued at AUD $107 million (1.1 times sales), will build Allegion's presence in its Asia-Pacific market, specifically Australia. Isonas, which generated $6 million of sales in 2017, sells commercial access control products and services. Given the small size of Isonas, Allegion should be able to leverage its scale and distribution networks to greatly enhance the market potential of Isonas products. Furthermore, we think Allegion can integrate Isonas' power over the Ethernet technology into other products. Management expects to generate $380 to $400 million of free cash flow in 2018, so Allegion will easily be able to fund these deals. While Allegion has become more acquisitive, the firm continues to make small acquisitions that have a clear strategic purpose, in our view.