RBC On Machinery: Allison Transmission Initiated At Outperform, Cummins At Sector Perform

RBC Capital Markets’ Seth Weber initiated coverage of Allison Transmission Holdings Inc ALSN with an Outperform rating and of Cummins Inc. CMI with a Sector Perform rating.

Allison Transmission: A leader In Commercial Duty Transmission Market

The price target for Allison Transmission is at $30. Analyst Seth Weber mentioned that the company is a leading player in the fully automatic commercial duty transmission market. Allison Transmission’s strength lies in its robust margins, which support strong cash flow and capital allocation opportunities.

The analyst expects Allison Transmission’s core North America markets to outperform the balance of the Class 8 category for the next two years. The Class 8 straight truck market is expected to reaccelerate in 2017, after a pause in 2016 and the company’s shares are likely to rise with an increase in orders.

“Allison has opportunity for share gains in Class 4-5 and Class 8 metro, while developing market exposure is low,” Weber wrote, while adding that the company’s low capex and substantial tax shield support robust free cash flows.

Allison Transmission is expected to use its FCFs for debt reduction, dividends and share repurchases.

“Although Allison's high-margin oil & gas related revenue is likely to decline again in 2016, we believe the steep drop off puts it closer to trough than peak and a potential rebound could serve as a catalyst,” the RBC Capital Markets report stated.

The company’s Defense business is underappreciated, given major wins by its customer and additional potential opportunities arising from US DoD budget funding for wheeled vehicles.

Cummins

The price target for Cummins is at $98. Weber believes that a softening NAFTA C1 8 truck cycle and concurrent challenges in other markets would offset Cummins’ growth initiatives and leading position in the move toward reduced engine emissions and greater fuel economy.

Cummins is a leading manufacturer and distributor of diesel and natural gas engines, components and power gen systems. The company is aiming to use its under-levered balance sheet for acquisitions and additional partnerships.

Weber believes that lower NAFTA has negative implications for the Engines and Components segments, with the latter expected to post its first decline since 2012. He added, “We forecast flattish 2017 Class 8 build (versus some calls for stronger upturn), with recent fleet refresh and capacity adequate for industry fundamentals, in our view.”

Cummins expects the six-point gain in med-duty share of 78 percent in 2015 to retreat to 72-75 percent in 2016, amidst a flattish market. The company also expects a drop in its Industrial revenue, with Power Gen also likely to be down again.