Morningstar | Electromechanical and Digital Locks Boosts Assa Abloy Organic Growth; Shares Fairly Valued
We are maintaining our wide-moat rating on Assa Abloy and expect to make moderate changes to our forecasts, increasing our fair value estimate by about 5% to adjust for full-year results and rolling our model forward. Shares look fairly valued. Fourth-quarter and full-year results reflected good mid-single-digit organic growth, at a time many investors are worried about the business cycle peaking. However, both the EBIT margins and reported ROCE were down by 30-60 basis points from a combination of raw material cost inflation, acquisition dilution and, to a smaller extent, revenue mix. Cash flow growth (+11%) would have been flat if not for a lower than usual capital expenditure, which should rebound. We expect the company to claw back about 20 basis points of margin as the mismatch in timing of price increases relative to cost inflation reconciles in 2019. The company should also be able to increase margins on acquired businesses, which tend to be lower, but can benefit from Assa Abloy's large distribution and manufacturing scale. Therefore, we don't see management's target of 16%-17% EBIT margins as a stretch goal from the 15.4% reported in 2018.Assa Abloy made 19 acquisitions in 2018 and is a regular acquirer of small bolt-on businesses in innovative higher-growth product categories like digital locks. As a company with fairly high returns in the mid-teens, moderately increasing its growth trajectory should lead to greater valuation creation. U nderlying organic revenue growth has averaged 3% since the Great Recession but picked up in the past two years to 4%-5%, we think because of increasing exposure to a long-term upgrade cycle to digital and electromechanical locks. That said, company earnings are not immune to the cycle. The company saw weakness in France, which echoes the comments made a couple of months ago by Legrand on a slowdown in construction there. However, its product mix provides some defense against cyclical forces.
ASSA ABLOY provides a range of door opening solutions. Co. is organized into five divisions. Europe, Middle East and Africa division, Americas (North and South America) division and Asia Pacific (Asia, Australia and New Zealand) division manufacture and sell mechanical and electromechanical locks, security doors and hardware in their respective geographical markets. Global Technologies division operates worldwide in the product areas of access control systems, secure card issuance, identification technology and hotel locks. Entrance Systems division is a global supplier of entrance automation products and service.
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