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Here's Why You Must Hold on to Allegion (ALLE) Stock for Now

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We issued an updated research report on Allegion plc (ALLE - Free Report) on Aug 21.

This security and safety services provider currently carries a Zacks Rank #3 (Hold). Its market capitalization is approximately $8.3 billion.

Let’s delve deeper and discuss the company’s potential growth drivers and possible headwinds.

Factors Favoring Allegion

Financial & Share Price Performances: Allegion delivered better-than-expected results in two of the last four quarters, with an average positive earnings surprise of 4.38%. Notably, the company’s earnings in the second quarter of 2018 were $1.25, surpassing the Zacks Consensus Estimate of $1.20 by 4.17%. Moreover, earnings increased 12.6% year over year on the back of healthy organic sales growth, synergistic benefits from acquisitions and forex tailwinds.

For 2018, Allegion anticipates adjusted earnings per share of $4.35-$4.50 per share (guidance maintained), above $3.96 recorded in 2017. Revenues are predicted to grow 12.5-13.5% versus the earlier prediction of 10.5-11.5%. The revised forecast includes organic sales growth projection of 4-5%.

We believe that solid financial results and outlook have been instrumental for the company’s stock price rally of 11.5% in the past month. This return has comfortably outperformed 6.8% increase recorded by the industry.

The Zack Consensus Estimate for the company’s earnings is currently pegged at $4.48 for 2018 and $4.89 for 2019, reflecting year-over-year growth of 13.1% and 9.2%, respectively. Earnings estimates for third-quarter 2018 are pegged at $1.23, representing growth of 20.6% over the year-ago quarter.

Solid Segmental Business & Investments: Allegion operates in three reportable segments — the Americas; Europe, Middle East, India and Africa (EMEIA), and the Asia Pacific. For 2018, sales in the Americas segment are anticipated to grow 10.5-11.5% versus 10-11% expected earlier on the back of strengthening non-residential market, solid demand for electronic products and stable product-demand in single-family construction. For the EMEIA segment, sales growth is predicted to be 14-15% versus 13-15% expected earlier while is likely to be 38-40%, way higher than 8-10% expected earlier for the Asia Pacific segment.

Allegion is making incremental investment to develop products and keep updating its current offerings. For 2018, the company anticipates investing 15 cents per share, a 5-cent increase from its earlier budget, for promoting its electronics products in North America and the development of products.

Strengthening Portfolio Through Inorganic Activities: Acquisition is one of the favored growth options for Allegion. In July 2018, it acquired the Door and Access Systems business of GWA Group Limited, and ISONAS Security Systems Inc. while added Aurora Systems, Inc. — a manufacturer of high-performance interior and healthcare door systems — to its portfolio in March.

In second-quarter 2018, the Technical Glass Products (acquired in January 2018) and AD Systems buyouts added 5.6% to sales growth recorded by the Americas segment while Qatar Metal Industries (acquired in February 2018) buyout contributed 5.7% to EMEIA segment’s sales. Beside acquisition, divestments of selected assets have helped in reshaping the business portfolio over time.

Factors Working Against Allegion

Dependence on Construction Market, Poor Valuation: Allegion’s business is highly dependent on the residential and non-residential construction markets of the United States. Any cyclical downturns in these markets may adversely impact the company’s financials. Moreover, ongoing supply chain constraints in the construction market are delaying projects, creating uncertainty about the timing of revenue generation by Allegion.

Additionally, overvaluation compared with the industry is making us cautious about Allegion’s stock. The stock currently has Price-to-Earnings (P/E) multiple of 21, above the industry’s multiple of 19 for the past month. Further, the stock’s current multiple is above the median multiple of 19.6.

Adversities Arising From Rising Costs: Allegion is dealing with an adverse impact of rising cost of sales. Notably, the company’s cost of sales in the last five years (2013-2017) moved up 2.1% (CAGR) while its selling and administrative expenses increased 3.8%. Notably, in second-quarter 2018, the company’s cost of sales increased 15.4% from the year-ago quarter while selling and administrative expenses moved up 10.9%. Operating margin decreased 50 bps in the reported quarter due to incremental investments, inflationary pressure and dilution caused by acquisitions. Allegion predicts inflationary pressure to continue for the rest of 2018.

Cash Position: A weak cash position can be concerning for Allegion. Cash and cash equivalents of $190 million at the end of the first half of 2018 declined 59.3% from the balance at the end of 2017. Likewise, the company’s cash ratio has declined from 1.01 at 2017 end has fallen to 0.40 at the end of the first half of 2018. Cash ratio below 1 indicates the company’s inability to pay off its short-term liabilities while a falling ratio seems to be worsening the situation.

Stocks to Consider

Some better-ranked stocks worth considering in the Zacks Industrial Products sector are Altra Industrial Motion Corp. (AIMC - Free Report) , Chart Industries, Inc. (GTLS - Free Report) and Barnes Group Inc. (B - Free Report) . While Altra Industrial Motion sports a Zacks Rank #1 (Strong Buy), both Chart Industries and Barnes Group carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

In the past 60 days, earnings estimates for each of these stocks improved for the current year and the next year. The average positive earnings surprise for the last four quarters was 4.01% for Altra Industrial Motion, 29.36% for Chart Industries and 6.88% for Barnes Group.

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