Morningstar Magazine - August/September 2018 - 55

Winning by a Wide Margin
Allegion boasts industry-leading profitability.

BEST IDEAS: EQUITY

Brian Bernard

Allegion ALLE

This article is adapted from a Morningstar equity research report dated
June 1, 2018.

Stats 05/31/2018

Allegion ALLE is a global security products company that primarily sells
mechanical and electronic locks and access control systems, doors,
and door frames and hardware. Based on U.S.- denominated revenue, we
estimate that Allegion is the third-largest security products company
in the world and the second largest in North America behind wide-moat
Assa Abloy ASSA B: SE.
Allegion's strong positioning in the Americas, which represents 73% of sales
and 89% of operating income, has been the main driver of the firm's
consistent and industry-leading profitability. Allegion's strong operating
margins have been remarkably stable throughout the business cycle. In fact,
margins improved during the 2008 - 09 global recession, a testament to
the firm's market presence and pricing power.
Despite rivalry from formidable competitors, Allegion has consistently
capitalized on its brand equity, strong distribution network, and large installed
base to drive returns on invested capital that are well above its cost of capital.
We believe Allegion is well-positioned to maintain its competitive advantages over the next 20 years. As a result, Allegion has a wide economic moat,
supported by intangible assets and customer switching costs.
Allegion has a portfolio of established brands associated with superior quality
in both residential and commercial markets, which supports pricing power.
Within North America, Schlage (locks and access control), Von Duprin (door
exit devices), and LCN (door closers and controls) hold leading market positions,
while CISA and Interflex are leading brands in some European markets.
Allegion has strong relationships with a large network of architects, homebuilders, security integrators, general contractors, and locksmiths that
drive new construction business and generate aftermarket sales. The company
also has a strong foothold within big-box retailers and e-commerce platforms.
Overall, we see Allegion's broad distribution network as a barrier to entry.
Allegion benefits from customer switching costs, especially in its commercial
installed base, owing to its deep expertise in code standards and a
long list of successful commercial projects. Although customer switching

Morningstar Rating
QQQQ

Sector
p Industrials

Industry
Security & Protection
Services

Price
$76.43

Fair Value Estimate
$91.00

Uncertainty
Medium

Economic Moat
Wide

Stewardship Rating
Standard

Market Cap
$7.7 Billion

Price/Fair Value 05/31/2018

$100
Month-End Closing Price

91.00
80
76.43
60

Fair Value Estimate Per Share

40
06/2015

06/2016

06/2017

The stock was not under Morningstar coverage between 01/2016 and 07/2017.

costs are much weaker on the residential side of the business, homebuilders
have incentives to install well-known, premium security products.
We expect Allegion to capitalize on growing commercial retrofit and upgrade
spending that is fueled by rising security concerns and the convergence
of electronic and mechanical security solutions. The firm should also benefit
from strong U.S. residential construction activity and strategic acquisitions.
Already-strong operating margins should benefit from a mix shift to
electronic products, operating leverage on increased volumes, and improved
foreign segment profitability as those businesses mature and gain scale.
Allegion's shares currently trade at about a 15% discount to our $91 per share
fair value estimate, which we think is an attractive entry point for investors
who would like to own this high-quality, wide-moat security products company
that boasts a strong North American market share. K
Brian Bernard, CFA, CPA, is an equity analyst with Morningstar Research Services.

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Table of Contents for the Digital Edition of Morningstar Magazine - August/September 2018