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Allison Transmission Holdings, Inc.: Initiation of Research Coverage

Wednesday, June 25, 2014

William Blair & Company initiated research coverage of Allison Transmission Holdings, Inc. (ALSN $36.00) with an Outperform rating and Core Growth company profile.

Analyst Lawrence De Maria estimated that the company would generate earnings per share of $2.30 in 2014 and $2.60 in 2015.

“Allison Transmission Holdings has a solid operating profile, given its industry-leading operating margins with strong, consistent free cash flow generation,” De Maria said. “Most of Allison’s capital investments are complete, and the company is in position to benefit from them. In addition, the long-term trends for fully automatic transmission, the company’s core product, are favorable, and a gradual cyclical recovery in many of its end-markets is underway or close to occurring. We also believe deleveraging and shareholder return profile (dividends and share repurchases) should drive further share price appreciation. Furthermore, Allison’s stock liquidity has improved, and the financial sponsors, Carlyle and Onex, will soon be completely out of the stock, removing an overhang on the share price.”

He added, “Allison has demonstrated the ability to perform well through cyclical downturns in its end-markets. Sales declined only 5% in 2008 and 15% in 2009, and adjusted EBITDA actually stayed flat in 2008 and fell 8% in 2009. Under private-equity ownership, EBITDA margin improved from 25% to 33% in four years. Despite pronounced softness in fracking, mining, defense, and hybrid bus markets in 2011, 2012, and 2013, EBITDA margins did not fall considerably. The company has been able to reduce fixed costs including SG&A expense during periods of end-market weakness, resulting in low EBITDA decremental margins.

“Most importantly, free cash flow has been consistently positive, and from this perspective, the cash flow generation is not too dissimilar from Wabco and, in fact, is arguably better. As a percentage of adjusted EPS, the company generates on average more than 120% of free cash flow per share. High amortization costs represent close to 30% of the add-back. Excluding amortization, conversion rates are roughly 90% and more in line with high-free-cash-flow peer Wabco.

“Lastly, there are structural and cyclical benefits for Allison and its products,” he said. “These include driver shortages in North America, which means fleets are buying more automatic transmissions for drivers, as well as the possibility of international expansion as other countries adopt similar fully automatic transmission products on their trucks and buses.”

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