Assa Abloy: Fair value höjs till 215 kronor

AKTIE: Starka varumärken, kundernas höga kostnader för att byta låssystem och stor eftermarknad gör Assa Abloy till en branschledare även framöver. Morningstars analytiker höjer fair value till 215 kronor per aktie (2021-05-27).

Morningstar Equity Analysts 2021-05-27 | 11:53
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Analyst Note | May 27, 2021

We believe Assa Abloy's medium-term 10% revenue growth ambition is becoming less of a stretch due to evidence of an increased pace of new product introductions, particularly in digital and integrated security solutions across the group. The company's capital markets day reinforced our thesis. Historically, the Global Technologies division has given birth to most of the company's product innovations but mainly for the division's own customer base. In the last three years, 27% of the division's sales have come from product launches. Encouragingly, at the CMD we saw evidence of other divisions using technology from Global Technologies to rollout digital products across more customer segments in the group. These product introductions have the potential to accelerate the core's revenue growth. We believe that growth will be fueled by a growing appetite for digital locks and integrated security systems across all building types after the pandemic, due to product features such as touchless door access and ability to remotely manage and track building visitors. We maintain our wide moat rating and fair value estimate.

Lock on red door

The company expects half of the 10% revenue growth to come from acquisitions and other half from organic growth. Historically, Assa Abloy has been expanding its sales organically by 2%-3% and acquiring about the same amount of growth. However, we recently increased our forecasts with a higher organic medium-term growth. Our 6% medium-term growth forecasts includes around 4.5% organic growth and 1.5% from acquisitions.

We forecast medium-term EBIT margins reaching the top of the company's 16%-17% margin corridor as it builds scale and captures synergies in its entrance systems (industrial door) division through ongoing acquisitions and increases the service attachment rates across its installed base. Around 25% of the division's revenue comes from service, and that is likely to grow over time with an accretive effect on margin.


Business Strategy and Outlook | Oct 21, 2020

Assa Abloy has significant growth potential as it benefits from structural changes. There are two key drivers of future growth. First, we expect an industrywide shift toward software-driven products, expanding functionality and linking locking systems with other building systems. Second, emerging-market demand will move up the quality curve to more sophisticated locking solutions, in which Assa Abloy is a leader.

If the spectrum of today’s locks were defined by a basic mechanical lock on one end and a software-controlled locking system on the other end, the company's product portfolio would be heavily weighted toward the latter. Advances in the past decade have expanded the functionality of lock systems to enable ever more precise access parameters, as well as enhanced identification of lock system users. For example, a building administrator would be able to provide a registered visitor with temporary access to a computer for a specified two-hour window on a particular day. Technological improvements are shortening the upgrade cycle for locks, as customers are eager to implement new security-enhancing features.

We expect the shift toward increasingly software-driven locks will continue over the long term, with the company’s global technologies division forging the path. The division is experiencing good initial success in selling virtual keys, typically issued on a temporary basis to mobile phones.

Asia and other emerging markets lag in locking solutions, with underpenetration of electromechanical locks, such as those linked to a keycard reader. Pent-up demand in the region, combined with strategic acquisitions, fuelled a fivefold increase in Assa Abloy’s Asia-Pacific revenue over the past decade, with organic revenue growth averaging 5% from 2005 to 2013 (before China’s property bust). For buildings with multiple daily users, there are obvious benefits from upgrading to more sophisticated systems that can track and limit building access. We think Asia and other emerging markets offer a long runway of demand for Assa Abloy's products.


Economic Moat | Oct 21, 2020

We think Assa Abloy has a wide moat based on high customer switching costs, significant aftermarket sales, and intangible assets built from high-quality, innovative brands.

The company has four product groups: mechanical locks; electromechanical locks; security doors; and entrance automation, such as revolving, hangar, and loading-dock doors. Through acquisitions and organic growth, its product mix has changed dramatically in the past 20 years. Mechanical locks are no longer its core product, contributing less than 30% of 2015 revenue, a far cry from being the company’s sole product category in 1994.

Products are mainly distributed through third-party channels such as security integrators, lock wholesalers, and locksmiths. The company often works directly with customers to customize solutions and assist in on-site testing. Assa Abloy has a team of over 500 “specifiers”: advisers with an engineering background that can work with building security architects. For example, at a Hong Kong government building that commissioned the installation of 4,000 locks and 200 doors, Assa Abloy also provided the CEO’s office with a bullet- and blast-proof door. For one of the Swiss utilities, the company installed a locking system that remotely grants permission for electronic keys to plants and distribution sites only within the hours that a technician is scheduled to be on site.

Assa Abloy’s relationships with the installers and security systems experts have been built over many years and present a barrier to potential new entrants. The company is the global industry leader and can boast of an impressive list of reference projects that prove the trustworthiness of its products. Its locks protect some of the world’s most security-sensitive buildings, including the European Parliament in Brussels, the Mexico City International Airport, the Rolls-Royce Aerospace division in the United Kingdom, and the Whitney Museum in New York. Given the sensitivity of the security sector, customers tend to be conservative in switching brands and are unlikely to switch for the sake of cost savings alone.

The company’s operating income margins and returns have been remarkably stable over time, even during the global recession of 2008-09. We attribute this to the stability of its market share position, pricing power, and significant aftermarket sales.

Two thirds of company revenue comes from aftermarket sales, consisting of upgrades, replacement components, software, and keycard issuance. Customer switching costs and aftermarket sales are supported by the long life of the company’s products, which can span a building’s lifetime.

For mechanical locks (29% of group revenue and shrinking), the aftermarket is usually an upgrade to a better mechanical lock with more-secure features, or to an electromechanical lock. Upgrades also drive electromechanical lock aftermarket sales, but so do higher-margin products, such as software and replacement keycards. Customers of electromechanical locks also need to replace the electrical components, which tend to wear faster than mechanical ones.

For example, the keycard reader paired with an electromechanical lock might use plastic keycards with a magnetic strip, or RF chip, that allows the card to communicate with the card reader. Once the card identification has been approved, the reader releases the lock. The entire system (the metal lock, the keycard reader, and the individual keycards) is sold by Assa Abloy. Each device in the systems consists of different components. A plastic keycard could have many parts: the plastic covers, a copper wire antenna, and an integrated circuit. Therefore, the time to the next repair is only as long as the weakest component. (Assa Abloy’s warranty on electrified components tends to be only two years, versus 10 years to a lifetime on the mechanical portion of a lock.)

Keycards can also be lost or damaged and need to be replaced. Assa Abloy charges per keycard or, for a significant premium, on a virtually unlimited basis, as is the case with hotels. (The Starwood chain of hotels is one of the company’s hospitality customers.)

Assa Abloy reports its revenue by divisions, which are mainly defined by geography, but include two separate product divisions: entrance systems and global technologies, the latter of which is very interesting from a moat perspective.

The global technologies division includes a subsidiary called HID that sells some of Assa Abloy’s most cutting-edge products, including software-controlled entry systems that can tie into a customer’s other systems. HID offers virtual keycards, which utilizes software to dynamically issue either permanent or temporary digital keys to a mobile phone, a smartwatch, or another Internet-enabled device. This enables tighter security, as digital keys can be tailored for specific access by rooms, time of day, or other connected hardware in a building, such as computers. Its software is designed to be interoperable with other software so that it can link into a building’s central security system. For example, when someone touches their mobile phone to a keycard reader, the camera positioned above the door will send the person’s identity and image to building’s security personnel. Integrating its systems with those of its customers increases the stickiness of Assa Abloy’s relationships with its customers.

Launched in 2014, the Seos system is the company’s latest product for total system integration. Before its release, Seos was tested for several years by some of Assa Abloy’s customers, helping to ensure its interoperability with other building systems. Today, its cumulative orders are only in the millions of dollars, but have already positively contributed to the division’s operating margin. We expect takeup of the system to accelerate in the coming years.

The company’s reported returns by division are highest in its most mature geographic markets--Europe, the Middle East, and Africa and the Americas--where it reports returns on capital employed in excess of 20%, versus low teens to midteens levels for the other divisions. We expect the group return on invested capital to improve in the medium term from 14% in 2015 to 16% in 2020, driven by improving margins in the global technologies and Asia-Pacific divisions.

Assa Abloy’s intangible assets come from the strength of its brands, which have leading market positions and a reputation for reliability and innovation. Among its brands is Assa Abloy, formed in a 1997 merger of two longtime Scandinavian lock manufacturers: Assa (from Sweden) and Abloy (from Finland). Both companies can boast of breakthrough inventions in mechanical locks in the early part of the 20th century. On a global scale, Assa Abloy’s best-known brands include Yale, HID, and Mul-T-Lock; at the local level, they include Lockwood, Sargent, and Crawford. The company employs 1800 engineers and spends 3% of its sales on research and development, which helps to create an innovative and regularly updated product portfolio.


Fair Value and Profit Drivers | May 21, 2021

We increase our fair value estimate to SEK 215 from SEK 200 per share, incorporating moderating ongoing small acquisitions, in line with the company's strategy, as well as the time value of money.

For 2021, we forecast 5% revenue growth including acquisitions and around 200 basis points negative currency dilution. We expect margins to see a small negative impact from material price inflation, nearly offsetting gains from operating leverage and volume recovery. We forecast a 15.7% 2021 EBIT margin, up 10 basis points from 2020 and below the company's stated margin corridor of 16%-17%.

In the medium term, we forecast 6% annual revenue growth, including 1.5% acquired growth compared with the company's stated goal of 10% growth with roughly half coming from organic growth and the other half from acquisitions. Assa Abloy has been expanding its businesses organically by 2%-3% and acquiring about the same amount of growth. We expect those trends to continue as Assa Abloy continues to pick up local champion lock brands and bring them into its larger-scale assembly plant and distribution. We forecast medium-term EBIT margins reaching the top of the company's 16%-17% margin corridor as the company builds scale and captures synergies in its entrance systems (industrial door) division through ongoing acquisitions.


Risk and Uncertainty | Oct 21, 2020

We give Assa Abloy a medium uncertainty rating. The company's product demand is tied to cyclical drivers like the construction and remodelling cycle. However, its revenue also has a strong recurring component. Two thirds of the revenue comes from aftermarket sales, which are mainly replacement keys, key cards (as in hotel or office building plastic key cards) and lock replacements from a break-in for example. The company has low operating leverage, enabling it maintain relative margin stability through the cycle.

We see few risks from an environmental, social and governance standpoint. The company's products are key to building security and any product default could cause a loss of property for end users. However, Assa Abloy's locks are made in line and sometimes even exceed local requirements. We see a product defect causing material harm to firm's reputation as a low probability event.


Capital Allocation | May 21, 2021

We assign Assa Abloy a Standard capital allocation rating. Assa Abloy's acquisitions focus on increasing its market share of local leading lock brands, expanding its geographic reach. Mechanical locks in an installed base of lock suppliers have the potential for conversion to electromechanical locks, one of the primary drivers of the company's business in the medium and long term. We believe this is prudent capital allocation as these small local acquisitions increase Assa Abloy's installed base of mechanical locks with potential to electromechanical conversion, taking advantage of the scalability of the company's broader electromechanical conversion strategy.

That said, given the pace of acquisitions, we previously doubted that back-end systems of the acquired companies, particularly those related to working capital (such as invoicing to customers, payables to suppliers, and inventory management), were integrated at a corporatewide software level. We saw evidence of this disconnect in 2016 when Assa Abloy revealed that unbeknown to the corporate level, one of the acquired Chinese subsidiaries had been overstating revenue. However, new management has implemented internal controls to integrate acquisitions, including a new system of designating one person to oversee the integration process of each acquisition.

Debt levels and dividend distributions are both well balanced with business needs.

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