Allegion Earnings: Concerns Over Lower Volumes Overshadow Strong Margin Expansion

We’ve maintained our $135 per share fair value estimate for shares of wide-moat Allegion ALLE following its second-quarter earnings release. While consolidated organic revenue increased nearly 6% year over year to $913 million, that gain came entirely from price (contributing 9 percentage points to organic growth) as volumes slid 3% year over year. Lower residential and non-residential mechanical product volumes in the Americas more than offset continued strong demand for electronic products, and Americas segment volume declined approximately 2% year over year. We believe the market is concerned that lower non-residential volume is directly tied to a weakening commercial real estate market, but management attributed the decline more to temporary channel destocking as distributors adjust to Allegion’s shorter lead times. While Allegion is not immune to the challenged office real estate market, it has far more exposure to institutional end markets (like healthcare and education), which have been resilient. We’re not surprised by lower Americas residential mechanical volumes considering the slower pace of home sales in the United States, but that’s not a permanent issue, in our view. International segment volumes (down over 6%) are primarily due to the Global Portable Security business, but we think that business is stabilizing.

Allegion realized strong profit margin expansion during the quarter; consolidated adjusted operating margin expanded 130 basis points to 22.2%. Excluding the recently acquired Access Technologies business, which is margin dilutive, adjusted operating margin would have expanded 370 basis points to 23.6%. Strong pricing and productivity savings were primary contributors to Allegion’s margin expansion.

Management lowered the midpoint of its organic revenue growth guidance by 50 basis points to 6% but raised midpoint guidance for adjusted EPS by $0.10 (to $6.75), and free cash flow midpoint guidance is higher by $20 million (to $510 million).