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Morningstar | Allegion's Strong Growth Continued in 4Q; Sees 5% to 6% Sales Growth and Margin Expansion in 2019

Wide-moat-rated Allegion enjoyed another quarter of double-digit reported revenue growth with its fiscal fourth-quarter sales up almost 13% year over year to $702 million. However, Allegion's strong top-line performance was just shy of Wall Street's expectations for $703 million. Excluding acquisitions and currency translation, sales were up a solid 7%, driven by an approximate 5% increase in volume and 2% increase in price. Allegion's 2018 acquisitions had a dilutive effect on adjusted operating margin, which contracted 130 basis points year over year to 20.7%. However, excluding acquisitions, Allegion's legacy business operating margin expanded 20 basis points despite unfavorable price/cost and investment spending. Adjusted EPS of $1.22 was in line with the consensus estimate and increased 10% year over year.

Allegion's top line has benefited from growing demand for electronic products, and we expect that trend to continue for all three of the firm's segments in 2019. Management also noted that while nonresidential end markets remain healthy in the United States, the team expects softer U.S. residential construction in 2019 compared with last year. Management also noted weakening demand in Australia and New Zealand. Still, overall, Allegion expects 2019 reported and organic revenue to grow 5% to 6%. Management also expects better price realization, improved productivity, restructuring at recently acquired Qatar Metal Industries, and moderating inflation to result in margin expansion across the firm's three segments and adjusted EPS growth of 6% to 9% ($4.75 to $4.90 2019 adjusted EPS versus $4.50 in 2018). While Allegion's 2019 outlook is solid, it did fall below both our and consensus expectations. Still, we expect to raise our fair value estimate modestly as the favorable impact from the time value of money since our last model update more than offset our tempered near-term growth assumptions.

We think management's bullish outlook on the firm's growth opportunity from electronic products is appropriate. Such products are already driving strong growth (high-teens full-year growth in the Americas, according to management), and penetration rates are still quite low. Management's assessment of U.S. nonresidential end markets also seems reasonable based on commentary from other companies we follow that play in the same end markets (albeit selling different products). However, we think management's view that U.S. new residential construction will come in softer than last year could prove conservative if the spring selling season comes in better than expected with 30-year mortgage rates falling to the lowest levels in a year. The February Housing Market Index reading, commonly referred to as the builder confidence index, reached a four-month high, which could bode well for new residential construction if that trajectory continues.

Allegion's Americas segment (73% of 2018 revenue and 91% of segment operating income, which excludes corporate expense) increased sales 13% (8% organic) year over year. Excluding acquisitions, nonresidential revenue grew low double digits and residential revenue was flat year over year. Americas adjusted operating margin fell 190 basis points year over year to 26.8% due to the margin-dilutive effect of acquisitions, unfavorable price/cost, and investment spending. Management expects the Americas segment to grow reported and organic revenue 5% to 6% in 2019.

The Europe, Middle East, India, and Africa segment grew both reported and organic revenue just over 4% year over year. EMEIA adjusted operating margin declined 230 basis points year over year to 14.3% as cost inflation, investments, and the margin-dilutive effect of acquisitions more than offset volume gains. Management expects the EMEIA segment to grow organic revenue 2.5% to 4.5% and reported revenue to increase 0% to 2% in 2019. Management's expectation for unfavorable currency headwinds explains the delta between organic and reported revenue guidance.

The Asia-Pacific segment reported a 45% increase in revenue year over year, but this extremely strong growth was mostly the result of the acquisition of Door and Access Systems, which closed in July. Excluding the contribution from this acquisition, Asia-Pacific revenue grew about 5%. The segment's adjusted operating margin declined 60 basis points year over year to 12.4% due to the margin-dilutive effect of acquisitions. Volume gains and productivity more than offset cost inflation, investment spending, and unfavorable mix. Management expects the Asia-Pacific segment to grow organic revenue 4% to 6% in 2019 (22% to 24% including the contribution from the Door and Access Systems acquisition).