Investors were pleased with TransDigm Group Incorporated (TDG) late last month when the company reported a strong September quarter. The maker of aircraft components turned in revenues of $189.9 million, good for a 12.6% increase over the fourth quarter last year. (The company operates on a fiscal year ending September 30, so the most recent report ended FY 2008). Adjusted earnings for the quarter were $0.78 which represents growth of 40.9%, and for the full year earnings were $2.79
Part of the growth over the past year was due to a couple key purchases of small companies. Management has historically relied on “tuck in” acquisitions as an important part of their growth strategy. Since the company operates in a very fragmented business, it makes sense to consolidate competing or complementing technologies under one business. TDG has a strong reputation of successfully integrating new businesses and maintaining margins of roughly40% which beats most other industry players. Typically TransDigm will only spend about $20 to $50 million on each individual acquisition.
Similar to Hewlett-Packard Company (HPQ), TransDigm has developed a strategy where it builds an installed customer base by offering the Original Equipment Manufacturer (OEM) a very attractive price on components. Then, just as HPQ makes their profits on ink, TDG makes the majority of profits by replacing or servicing the components during the lifespan of the existing aircraft. Since 95% of the company’s revenue is from items that TDG owns the designs to, the firm has a captive customer base and strong visibility when it comes to future earnings.
Looking towards the year ahead, TDG is not immune to the economic challenges. Decreased passenger loads have some airlines grounding planes, and a recent machinist strike at a Boeing plant will likely delay a few orders. However, management expects to be able to raise prices to make up for less growth in the number of items. Guidance is for 2009 sales of $740-770 million compared to $714 million in fiscal 2008. The company has implemented a cost-cutting initiative which has already shown results. Further efficiency gains are expected and management is guiding EPS for 2009 to be between $2.90 and $3.10. This compares favorably with the $2.79 reported for 2008.
The company is in relatively good shape financially. The balance sheet has $160 million in cash and management noted that they still have access to $200 million available in the form of revolving credit facilities. Still, with nearly $1.4 billion in debt, there is still a bit of financial risk associated with the company. This debt appears to be manageable with an attractive average rate near 6.8%, but if the company were to face significant reduction in revenue, the debt load could become an issue.
In general, the company appears to be a strong attractive investment candidate. The stock is trading at an attractive multiple and investors reacted enthusiastically to the most recent earnings announcement. The management team is strong with a proven track record, and the business is generating cash which can be used to strengthen the balance sheet, or to pursue additional acquisitions. In short, I believe this stock will be a strong participant when the market regains strength.
FD: Author does not have a position in TDG
TDG Notes
Additional Reading:
Minyanville: Airline Profits to Take Off
WSJ: Boeing Engineers Ratify Four Year Pact
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