Whenever the investment fund of a legendary investor like George Soros takes a position in a mid-cap stock such as security products manufacturer Allegion (NYSE:ALLE), investors will usually want to look at the company themselves. Recent 13F SEC filings from Soros Fund Management reveal that the fund had 5,000 shares of Allegion at the end of 2013, 214,353 by the end of June of this year, and 1,627,956 (worth about $90.6 million at the current price) by the end of September. What might have attracted the fund to this company, and should retail investors follow its lead?
A familiar investment theme
The Allegion position has two themes in common with another mid-cap stock the fund has been buying, electrical products and lighting company Hubbell. It's hard not to think that this is part of a thematic view at Soros Fund Management.
First, both companies are heavily exposed to the North American construction market, particularly commercial construction. Second, both companies have the opportunity to generate long-term growth through the delivery of value-added solutions as a result of technological change. In Hubbell's case, it's the opportunity for LED lighting and controls solutions to replace conventional lighting solutions. With Allegion, it's the potential to embed intelligent solutions within its security doors and systems.
Construction markets favorable
A quick look at Allegion's revenue and profit mix demonstrates its end-market exposure. According to a recent investor presentation, Allegion derives 62% of its revenue from the U.S., with the No. 2 revenue provider (Western Europe) a distant second at 17%.
Roughly 70% of its global sales go to the commercial construction sector (the remaining 30% is residential), with global revenue evenly split: 49% from new construction and 51% aftermarket. Moreover, for the first nine months of 2014, Allegion generated $320.1 million in segmental operating income from the Americas (which includes the all-important U.S. sales), with the EMEIA (Europe, Middle East, India and Africa) and Asia-Pacific regions losing $4.3 million and $7 million, respectively.
In other words, Allegion is a play on a recovery on the North American construction markets. The good news is that the most widely followed indicator of future growth in North American construction, the Architecture Billings Index, indicates that conditions are set to improve. In the chart below, a reading above 50 indicates growth. Despite the drop in November, the institutional reading has been positive for the last six months. According to the American Institute of Architects, the index "leads nonresidential construction activity by approximately 11 months."
A cyclical anniversary and products becoming more intelligent
Allegion is also coming up to the 10-year anniversary of the start of the construction boom in 2005, which means facilities are likely to begin upgrading their security doors and locks. It's not unusual for companies to depreciate plant and machinery at a rate of 10% a year, so on this basis, Allegion should see a pickup in end demand in the aftermarket.
Furthermore, Allegion has an opportunity to sell extra value-added solutions that include wireless and Web-enabled technologies. For example, the company recently released a new wireless lock utilizing its ENGAGE technology, which allows companies to configure locks and add and delete users via cloud-based mobile and Web apps -- a considerable benefit to corporate security efforts. It's a good example of the trend toward convergence of mechanical and electronic security products.
Moreover, during the company's last earnings call, CEO David Petratis argued that the new locks would not replace its existing sales: "We don't expect a lot of cannibalization ... we're opening up new markets."
Should investors follow Soros Fund Management into Allegion?
As attractive as Allegion might look as an investment, it's hard to see the stock as good value right now. A look at its forward enterprise value-to-EBITDA ratio suggests the company isn't cheap compared to Hubbell or Stanley Black & Decker. Those two companies are not perfect examples of competitors, but they are exposed to similar end markets.
All told, Allegion is a stock to watch, but cautious investors might want to wait for a better entry point before following Soros Fund Management into this company.