TDG - Transdigm

[Grenville]

"Meet The Martin Shkreli Of Defense Contracting"

http://www.huffingtonpost.com/entry/defense-contractor-monopoly-transdigm-mick-mulvaney_us_58d2f8dae4b0b22b0d19ad2a

[undervalued]

Can we make a poll similar to VRX thread? Just want to see what everyone's perception about TDG is at, at this point in time.

[thefatbaboon]

FWIW, I'm happy to go on the record and back Transdigm.  Not in the sense that they are a huge position for me or anything like that but in the sense that it's a good business and should do well.  They have made one mistake in my opinion -  advertise themselves inaccurately and too much and attract unwelcome attention.  Transdigm uses significant financial leverage and pays top dollar for companies with the hope that they will have a long profitable tail products and all this leverage and money "on the come" makes their risk-weighted economics look better than they actually are.  They talk of 60 year tails as if they know what the hell will be going on in the aftermarket in 2077!  The truth is is that no one really knows if the aftermarket in 2077 is going to be anything like todays - we might be flapping around with bird wings or traveling in teleporters.  Also the shareholder returns are misleadingly good.  Put 7 turns of leverage on any good cash flowing business during a 15 year period where Fed Funds are zero and look what happens to Return on Equity and share price.  Seriously.... go pretend to buy tobacco companies, or cosmetic companies, or beer or whatever in 2000 and keep reinvesting (or repurchasing stock) using 50% borrowed money and maintaining debt at 7 times ebitda.  You'll make 20%-30% returns.  There is nothing evil or unAmerican in what they did, it's a levered equity stub on a highly diversified and competitively advantaged low-dollar product portfolio and they think they've a shot at making money from their products for half a century. Perhaps they will perhaps they won't.

 

Now they are under attack and the optics are superficially unappealing from a political and public point of view.  Because everyone looks at the historical returns and all the debt and all their talk about moats and pricing and owning the aftermarket.  It all sounds so predatory (even though personally I don't think it is). But I'm fascinated by how this battle might unfold because of the sheer tininess and ubiquity of the TDG portfolio.  There are thousands of planes with tens of thousands of parts most of them costing airlines a mere $100 a day - not per plane but for their WHOLE FLEET!  There are no real monolithic parts to attack.  Also their economics are in the existing fleet not in design and oem. Getting Boeing or Airbus or Lockheed to gradually stop designing them in...well, that will take ages and probably only start with the next generation of production and what is to stop TDG buying whoever is installed?  But either way it should have no effect on their cash flows for many years - in fact quite the opposite, getting shut out from new design might even increase earnings for the next 10 years.  So any damage to this decades cashflows would have to come from deterioration in the aftermarket -  can the airlines get together and fund competitive spares?  There are a lot of airlines from many different countries (who are fierce competitors) who would need to agree to get to critical mass to get requisite economics to justify the move on such minuscule parts.  Can they?  Perhaps - but wouldn't they have done so already, wouldn't Heico or whoever have done it already?  Also it would only be where TDG wasn't protected by strong IP.  Anyway its all very interesting to watch.  I will say this in closing, that I think this is a fantastic test for the Transdigm model.  We stand to learn a lot about their market power over the coming quarters.  More than we'd ever learn from attending analyst days or reading annual reports.

 

Last point on position sizing, any investor should keep the following in mind.  The debt stack is significant which means a % change in the enterprise value effects equity a lot.  Last year enterprise value was a punchy 14 times ebitda.  If the market rerates that to 12 times then the stock price will go down to $185, or 10 times then it would go to $125.  So one must size any investment accordingly - remembering that whatever you're putting in today (say $20,000) the company has borrowed about the same again (another $20,000).  So if you are confident enough to invest $20,000 in the Transdigm business model don't buy $20,000 worth of stock - buy somewhere around $10,000 because the company is borrowing another $10,000 on your behalf.   

[Guest Schwab711]

Questions regarding TDG sales:

There are literally hundreds of thousands of parts, many of which have proprietary technology.  The biggest PMA supplier, Heico, which controls more than 50% of the market for generic parts (i.e. OEM knock offs) tells investors that they have the capacity to produce 300-500 parts per year. 

 

Do you know how many parts represent 10%, 25%, and 50% of total revenue? I'm thinking Heico probably wouldn't need to get a PMA for a large number of parts to compete against a high % of TDG's revenue.

 

I know any comparison to VRX has a ton of implications and I am not trying to imply anything like that with TDG. However, VRX had 1000s of drugs (and also said that no specific drug was a material portion of their revenue) but the top-30 drugs represented roughly 50% of total revenue. They were a lot more concentrated than most people expected once they went from reporting top-10 to top-30. Given TDG's business, I think it would be useful to know the revenue of their top-25 parts and/or how many parts represent 10%, 25%, and 50% of revenue. I imagine Heico would focus on the highest grossing parts and has no interest in getting a PMA for a part that has $10k/yr in sales.

 

TDG discloses that 90% of their revenue comes from parts with $2mm of revenue or less, that's on a $3.5bn revenue base.  PMAs are 2-3% of the market, and Heico says TDG parts are probably less penetrated then average because they aren't high enough volume to target.  They specifically say they tend to avoid TDG parts.  A $1-2mm part is worthy of being PMA'd, so it's safe to say the 90% of revenue is not 1500-3000 $1-2mm parts.  Many parts are also highly proprietary and can't be reverse engineered.

 

I'm aware of the stats that TDG provides on their portfolio (I didn't know the exact market share of PMA parts but I knew it was relatively low - it's also growing at a much higher rate than the overall aerospace parts market). I'm interested in the above questions because I think the stats they provide don't tell me enough about the portfolio to arrive at any real conclusions. This kind of goes to Spekulatius' questions and what you have been saying. TDG is a portfolio of commercial & defense aerospace parts and a large portion of these portfolio positions (parts) are in a 20-50 year run-off (I don't know exactly what TDG's estimated weighted-average remaining life is on these parts but we can probably safely assume it is within that range). The questions I asked are the same type of disclosure that nearly every type of investment portfolio provides, including portfolios of securities (ETFs, MFs, MBS, ect), major pharma companies, REITs, O&G, ect. Most aerospace suppliers are not structured like a portfolio so I don't blame TDG management for not disclosing this info already. If I were CEO, I would want to provide the least amount of disclosure possible. However, as a potential investor of a portfolio of run-off cash flows related to aerospace parts, I think I would need to know the answers to the questions I asked (along with a few others) to really understand the risk profile of the portfolio I'm invested in.

 

I think the stats TDG provides is somewhat misleading for a few reasons. 1) They don't really tell us much (details below); 2) TDG, like every other public company, is providing facts about their company that frame them in the best possible light. Thus, the stats you list should probably be considered from that POV; 3) As you know (but others may not), Heico is not the only generic (or PMA, to be specific to this industry) manufacturer around. There are dozens or hundreds of small, private PMA manufacturers that generally focus on specific systems within specific aircraft classes. There are a ton of companies that are trying to pick off profitable parts. The issue has been the OEM and airline's reluctance

 

So going off what we know from TDG, company websites prior to being acquired by TDG, some publicly available industry stats, and the fact that almost every company frames their stats in the best light (which gives us a reasonable boundary condition), I think we have the following:

The 10% that comes from > $2m/part parts:

What is the gross margin on these? Is it > or < overall margin? Are there a couple dozen parts that average >$10m/part and have 90% gross margin? Are the highest grossing parts for 737 and 747 models or are they for newer aircraft models? The 737 and 747 were discontinued recently so if it is the former then the twilight years have begun. While historically, the twilight years last for 30-50 years or so, have confident are we that that will be true going forward? What economic dynamics (incentives) caused that to be true previously? Are those conditions still true today and can we be reasonably confident they will be true going forward? If any of these are true, then there is a little more risk. But I don't know these answers because I don't know if it's even worth investigating because in general I don't know where the profit is generated. Anytime the narrative is difficult to prove, the business isn't visible to the average institutional investor, and investment pitches quote the narrative with little to no change between authors, I become suspect of the validity. As I've said, TDG obviously has a great business, but is it as good as everyone says? They have a run-off portfolio of 20-60 year cash flows and they purchase nearly all of their growth. Does it make sense to pay 25x-30x for that?

 

Also, since TDG has historically distributed nearly all of their profits by special dividend and those dividends are paid to vested employee options as well as stockholders, I think it makes sense to adjust the expected FCFs to account for the < 100% of cash flows common stock holders will receive. I never see anyone do that. It's only a ~8% or so adjustment but it is material. That's what I was getting at with the questions. How do I value a portfolio if it is a black box of variable cash flows?

 

My issues with the stats TDG reports:

The < $2m/part parts (90% of sales):

* In general, is gross margin higher for parts with low sales or high sales? I'd guess the $1m - $2m parts have higher gross margin than the one-off parts with <$500k/yr in sales but I don't know (because I don't know what those parts are).

* Is there a sneaker-like issue here where the gross margin is clumped into a few types of parts that have hundreds of different sizes? Thus, TDG is technically correct that they sell thousands and thousands of parts, but realistically they depend on a few valves or actuators, for a few base models of aircraft that have numerous sizes for all the different types of aircraft models (different valves for every type of Boeing 747, ect)? If so, then the <$2m/part statistic is misleading. Once you PMA one of those sizes, it should be fairly straightforward to obtain a PMA for each of the other sizes, though it will still take time.

 

 

I have the same opinion as everyone else. It's a great business, great industry dynamics, but I don't think the fort is as unbreachable as folks let on and I'm always suspect when no one can come up with any risks to the business.

[cmlber]

I didn't know the exact market share of PMA parts but I knew it was relatively low - it's also growing at a much higher rate than the overall aerospace parts market.

 

“Much” higher rate is a bit of a stretch.  PMA is growing 5% vs. market of 4%.  But to be fair to the bear case, that’s because engine PMAs are basically flat and everything else is growing 7-8%.  8% vs. 4% growth would mean in 20 years, PMAs go from 2.5% to 5% market share.  Hardly going to kill TDG.

 

The 10% that comes from > $2m/part parts:

What is the gross margin on these? Is it > or < overall margin? Are there a couple dozen parts that average >$10m/part and have 90% gross margin?

 

Odds are, these margins are about the same as, but a little higher than, everything else.  Why do I say that?  Everything in the after-market has very high margins, so the difference between 70% and 90% isn’t going to create the issue you’re talking about, where 10% of the revenue could be substantially greater than 10% of the profit.  But in order to get to that size without attracting PMA competition, those parts likely are more challenging to replicate.  A $10m part would get PMA competition immediately otherwise.  If you take Heico’s revenue divided by marketed parts, we can estimate that their average part generates ~$80k of revenue.  They say they target 20% of the market volume for a part and usually discount 50%.  So that means an OEMs $800,000/yr revenue part is an average target…

 

They have a run-off portfolio of 20-60 year cash flows and they purchase nearly all of their growth. Does it make sense to pay 25x-30x for that?

 

See earlier post, but they do not just have 20-60 year cash flows and purchase all growth.  They also have the benefit of being the status quo in a risk-averse industry.  The buyers at Boeing/Airbus are incentivized to keep the status quo, so unless an alternative is better, TDG parts are typically rolled from one platform to the next, hence the chart they show that they have more content on the new generations of aircraft than on the old generations.

 

My issues with the stats TDG reports:

The < $2m/part parts (90% of sales):

* In general, is gross margin higher for parts with low sales or high sales? I'd guess the $1m - $2m parts have higher gross margin than the one-off parts with <$500k/yr in sales but I don't know (because I don't know what those parts are).

 

I think your guess is the opposite actually.  It is the oldest parts, with the lowest volumes, that get the highest gross margins.  Why?  Because nobody in their right mind is going to PMA a part that sells 10 parts/year, so TDG can charge whatever it wants for those parts.  The counter to that though would be more proprietary content correlates to both higher prices and higher gross margins.

[Guest Schwab711]

Thanks cmlber, this is helpful. I'll have to think about this more.

[Liberty]

Fiscal Q2:

 

http://www.transdigm.com/mobile.view?c=196053&v=203&d=1&id=2271210

[Liberty]

http://www.transdigm.com/mobile.view?c=196053&v=203&d=1&id=2278225

 

TransDigm Group Incorporated (NYSE: TDG) announced today that it has recently acquired three add-on aerospace product lines for a total purchase price of approximately $100M. The product lines have combined revenues of approximately $32M.

[Gamecock-YT]

CNBC obtained a copy of a letter Senator Warren sent to the DoD on May 19th calling for an investigation into Transdigm's business. $TDG

[DCG]

Interesting. I sold my TDG holdings earlier this year (for around the same price it's currently trading at), as I simply realized I didn't have a good enough understanding of their business and industry.

[walkie518]

Warren represents the ugliest side of the current political discourse.  I don't understand why she has any credibility. 

[Liberty]

http://www.transdigm.com/investor-relations/news-releases/news-article/?myartid=2292486

 

Highlights for the third quarter include:

 

Net sales of $907.7 million, up 13.8% from $797.7 million;

Net income of $169.1 million, up 5.2% from $160.6 million;

Earnings per share of $3.08, up 6.9% from $2.88;

EBITDA As Defined of $442.9 million, up 15.4% from $383.9 million;

Adjusted earnings per share of $3.30, up 6.8% from $3.09; and

Reaffirms previously stated fiscal 2017 financial guidance.

 

There might be a new special dividend in the range of $1.0 billion to $1.25 billion.

[Liberty]

https://seekingalpha.com/pr/16922702-transdigm-group-announces-successful-completion-additional-term-loan-declares-special-cash

 

$22/share special dividend.

[Jurgis]

Will there be another article by shorts after divvie is paid? Get the popcorn!  8)

[Liberty]

I haven't followed this one in a while, but something's appears to be going on (if anyone who's been following can give me a recap, I'd appreciate it). I think I'll dig a bit deeper tomorrow to see what this asset disposition because of the DoJ is about:

 

Fiscal Q4:

 

https://www.transdigm.com/investor-relations/news-releases/news-article/?myartid=2315782

 

Highlights for the fourth quarter and fiscal year include:

 

Fourth quarter net sales of $923.9 million, up 5.6% from $875.2 million;

Fourth quarter net income from continuing operations of $184.1 million, up 19.1% from $154.7 million;

Fourth quarter earnings per share from continuing operations of $2.21, down 20.2% from $2.77;

Fourth quarter EBITDA As Defined of $460.1 million, up 8.7% from $423.3 million;

Fourth quarter adjusted earnings per share of $3.48, up 5.8% from $3.29;

 

Fiscal 2017 net sales of $3,504.3 million, up 10.5% from $3,171.4 million;

Fiscal 2017 net income from continuing operations of $628.5 million, up 7.2% from $586.4 million;

Fiscal 2017 earnings per share from continuing operations of $8.45, down 18.7% from $10.39;

Fiscal 2017 EBITDA As Defined $1,710.6 million, up 14.4% from $1,495.2 million; and

Fiscal 2017 adjusted earnings per share of $12.38, up 7.7% from $11.49.

 

During the fourth quarter of 2017, TransDigm began the process of disposing of our Schroth operations in connection with an agreement with the Department of Justice.  Accordingly, the Schroth results are presented as discontinued operations, and as such, $10.1 million of net sales are excluded from continuing operations for the quarter and $24.6 million of net sales are excluded for the full fiscal year. Schroth was previously acquired in February 2017.

 

Fiscal 2017 net sales, which excludes $24.6 million from discontinued operations, rose 10.5% to $3,504.3 million from $3,171.4 million in the comparable period last year.  Organic net sales growth was 2.4%.

 

Update: Found Nick Howley's comments on the disposition and posted them here:

[Liberty]

https://www.justice.gov/opa/pr/justice-department-requires-transdigm-group-divest-airplane-restraint-businesses-acquired

[Liberty]

CFO out:

 

https://seekingalpha.com/news/3320753-transdigm-taps-skulina-interim-cfo-paradie-resigns

[Spekulatius]

CFO leaving, especially for such an outfit ( highly leveraged, lots of acquisitions), is potentially a big red flag.

[Liberty]

CFO leaving, especially for such an outfit ( highly leveraged, lots of acquisitions), is potentially a big red flag.

 

The fact that he was coming from Cliffs in the first place had made me raise an eyebrow like Spock...

[matthylland]

Has anyone been to TDG's annual meeting before? Is it interesting or worth a few hour drive?

 

Annual Meeting

 

MEETING DATE: March 20, 2018

 

For Holders as of: January 22, 2018

[Liberty]

https://www.bloomberg.com/news/features/2018-02-14/boeing-is-killing-it-by-squeezing-its-suppliers

[walkie518]

https://www.bloomberg.com/news/features/2018-02-14/boeing-is-killing-it-by-squeezing-its-suppliers

 

this kind of behavior will spur a wave of consolidation among suppliers? 

[Liberty]

https://www.bloomberg.com/news/features/2018-02-14/boeing-is-killing-it-by-squeezing-its-suppliers

 

this kind of behavior will spur a wave of consolidation among suppliers?

 

It already has:

 

This, along with the ceaseless price squeezing (from Airbus as well as Boeing), has set off a wave of acquisitions as suppliers try to build leverage. Last April, Rockwell Collins Inc., which makes aircraft electronics, paid $8.6 billion for B/E Aerospace Inc., a supplier of cabin equipment including seats and lavatories. Just after the deal closed, Gregory Hayes, CEO of United Technologies, called his counterpart at Rockwell Collins, Kelly Ortberg, with a proposal. “I said, ‘Kelly, we need to do something,’ ” Hayes recalls. “ ‘The forces of nature in the aerospace business are such that we need to figure out how we’re going to reduce costs.’ ”

In September, UTC agreed to pay $23 billion for Rockwell Collins—weeks after Boeing set up a unit called Boeing Avionics to make its own cockpit equipment.

 

btw, I posted this in the TDG thread because there's no BA thread, but I don't mean to imply anything about the impact on TDG.

[Leverage Capabilities]

I think i remember a chart from one of their presentations where like ~75% of EBITDA As Defined comes from the aftermarket. My biggest concern based on the article would be if Boeing / Airbus start getting more and more into the aftermarket

[Liberty]

I think i remember a chart from one of their presentations where like ~75% of EBITDA As Defined comes from the aftermarket. My biggest concern based on the article would be if Boeing / Airbus start getting more and more into the aftermarket

 

Indeed. The article says that's one of their goals, but we'll have to see how effective they are at it, and whether they target specific sole-source parts that TDG has.