TDG - Transdigm

[scorpioncapital]

I can see the stock being cut almost in half from $230/share. The risk is not insignificant. Look at IBM...If growth stalls and high debt and the market re-rates the business to only slightly above average (although some might say IBM has a moat and look at it having traded recently at 10x earnings) then at $11.84 2017 earnings x (let's be generous) 15x = $177/share. But you'd think at 15x, a company would have some growth. If pricing power unwinds, then you go in reverse, and might even go to low $100s...Not saying this will happen, but this appears to be a case of front loading growth. Even the Fed does it with interest rates so it's not entirely unheard of. But the second part of the movie, after the intermission, needs some consideration. To their credit they own above average assets with moat-like attributes. The high debt can make any changes in that dynamic highly sensitive .

[thefatbaboon]

Why do you think pricing power would unwind?  Transdigm has parts on nearly every commercial plane being built or flying around today.  Do you think Boeing, Airbus, Gulfstream etc are speccing Transdigm OEM parts because a doctor prescribes them?  If they could get better parts elsewhere for less then that's what they would be doing.

 

Citroen suggests there's been some dishonesty by Transdigm in the DoD bidding process - but offers zero evidence.  As for the price gouging examples, the data they give is almost completely useless as it has no specifics regarding potential differences of versions of the item priced (assuming it is even the same), or the times of the different prices.  They also have offered zero justification for the assumed "organic decline rate".  It could be tactics - and maybe they will deliver more evidence in the coming days/weeks.  But so far I can see nothing useful in this report.

 

As you say with a heavy debt load any revaluation of the business' EV hits the equity hard.  That's simple arithmetic and obviously true.  But I guess I don't see the equivalent of Philidor type distribution or Jublia type product.  Transdigm sells thousands of relatively low cost parts for use on thousands of planes with terms established by commercial negotiations between grown-up businesses under the auspices of FAA regulation.  There are no insurance companies, or rebates, or doctors, or simple minded patients with fungus or sexual dysfunction.  If Boeing wanted different actuators on it's 777 it would specs it.  If Ryanair wanted to buy different aftermarket seat belts they would. And if competitors thought they could make a buck selling Transdigm type products they would pay for testing and get them passed by the FAA.   

[scorpioncapital]

I agree it doesn't look like Valeant. Sometimes I think without articles like this a stock would over time meet its natural strengths and weaknesses simply by the results achieved or obstacles encountered. Notice that in this report he tries to say its worth $166 and not a zero like he claimed for Valeant. He clearly does not believe his headline hence the question mark. A slowing of price increases and debt to market cap approaching 50-50 with an interest rate between 4% and 7% could result in some turbulence ahead.

[cmlber]

I agree it doesn't look like Valeant. Sometimes I think without articles like this a stock would over time meet its natural strengths and weaknesses simply by the results achieved or obstacles encountered. Notice that in this report he tries to say its worth $166 and not a zero like he claimed for Valeant. He clearly does not believe his headline hence the question mark. A slowing of price increases and debt to market cap approaching 50-50 with an interest rate between 4% and 7% could result in some turbulence ahead.

 

Actually, his price target was not zero for VRX, it was $50.  He's a con artist who shorts stocks, publishes scare pieces, then closes out when they fall and he got lucky one time with VRX and now everyone pays attention to him.  His original scare piece on VRX and R&O Pharmacy turned out to be nothing.  His price targets are established by randomly picking numbers materially lower than the current price.

 

He made it seem like this is a defense business in that piece, when in reality it's probably 30% defense, if that much.  He also pitched this as wait until the government actually cares about prices, TDG is in for trouble, but then his own piece linked to a report where the government did try to reduce TDG prices in 2006 and nothing happened.

[hooplaer23]

If you take a look at the full Inspector General report mentioned (http://www.dodig.mil/audit/reports/FY06/06-055.pdf), it makes many of the same points made in the Citron report.  It even talks about the use of dealers and how they are not independent of the manufacturer, which sounds like what Citron is talking about with its reference to "multiple shell distributors."  Here is an excerpt from PDF page 17 of the report:

 

"A sole-source manufacturer and a dealer cannot compete independently when the dealer is reliant on the sole-source manufacturer to fill the Government requirement. In the procurements reviewed, the prices quoted by the dealers were higher than the sole-source manufacturer and the delivery terms were mostly favorable to the sole-source manufacturer. As a result, the sole-source manufacturer was able to set the market price and had an inherent advantage in winning contract awards. Further, we surveyed 10 dealers about their normal processes when they quote prices for a Government requirement. The dealers consistently stated that they do not stock these parts and normally contact the sole-source manufacturer when a Government requirement becomes known. As a result, the dealers are not independent of the sole-source manufacturer."

 

But despite this report, as the previous post mentioned, 12 years later there does not seem to have been much of an impact on the company's defense business (of which the U.S. military is a subset).  I think the big question is whether the combination of the current political climate and Transdigm now being a bigger business makes it more likely that the government would be more effective in negotiating on price with Transdigm.  And then the follow on question is whether any scrutiny of pricing would carry over into the commercial aftermarket business, where a big portion of the company's profits are made.  In Citron's analysis, which removes the effect of price to calculate the impact on EBITDA and EPS, the assumption is that any pricing benefit is removed from the entire business, not just the defense business.  Given that the company likely does not make much margin on the commercial OEM part of the business to begin with, the pressure on pricing would have to come from the airlines, not simply Boeing and Airbus.   

[Gregmal]

What I've found is that after rather extraordinary events, everything becomes "the next (such and such)". There were plenty of "the next Enrons", plenty of well written and documented articles on "the next financial crisis", etc. VRX was rather incredible. Since the blow up, I've probably read a half dozen articles or write ups on "the next Valeant". The truth is, these rarely happen because people now look out for them. The next black swan will come from somewhere unexpected. And then there will be thirty million articles on "the next black swan".

[undervalued]

So I am reading TDG's 2016 proxy statement, on page 26 it says

 

Optionholders who hold vested stock options at the time a dividend is paid will receive a cash dividend equivalent

payment equal to the amount that he or she would otherwise have been entitled to receive had his or her vested stock

option been exercised immediately prior to payment of the dividend. Optionholders who hold unvested stock options may

receive a cash dividend equivalent payment equal to the amount he or she would otherwise have been entitled to receive

had his or her unvested stock option been vested and exercised immediately prior to payment of the dividend, but only if

and when such stock option vests pursuant to its terms. We believe that we have structured dividend equivalent

payments under the Company’s dividend equivalent plans such that they are not subject to any excise tax under

Section 409A of the Internal Revenue Code. Certain investors and proxy advisory firms have raised the issue as to

whether the Company should pay dividend equivalents only upon an exercise of the options; however, we believe that

tying payment of the dividend equivalents to the exercise of an option would result in excise taxes under Section 409A

 

Does this means options holders get paid before they actually exercise their options and they get paid special dividend just for holding the options? I guess this is one reason why management prefer special dividend rather than actual dividend. They can add loopholes around special dividend.

[thefatbaboon]

Yes they receive the dividend if the options have vested or end up vesting.

 

Why is this a problem for you?  It allows for a less conflicted analysis by management of share repo versus dividend.  And it doesn't force management to exercise at a time that may not be convenient or in a way and at a cost that may require a faster sale (to meet taxes on gains).

 

I have no problem with this. 

[KCLarkin]

How are people comfortable with the extreme leverage that Transdigm uses? Under normal business conditions, the business is pretty robust. But what happens if airlines start parking planes in the desert and cannibalizing planes for spare parts (e.g. 9/11)?

[cmlber]

How are people comfortable with the extreme leverage that Transdigm uses? Under normal business conditions, the business is pretty robust. But what happens if airlines start parking planes in the desert and cannibalizing planes for spare parts (e.g. 9/11)?

 

EBITDA has grown every year since 1993 including 2001, and they have no near term debt maturities.

[KCLarkin]

How are people comfortable with the extreme leverage that Transdigm uses? Under normal business conditions, the business is pretty robust. But what happens if airlines start parking planes in the desert and cannibalizing planes for spare parts (e.g. 9/11)?

 

EBITDA has grown every year since 1993 including 2001, and they have no near term debt maturities.

 

Thanks. Didn't realize they had financials available prior to the 2006 IPO.

[scorpioncapital]

"EBITDA has grown every year since 1993"

 

Interesting you bring up the year 1993...That's the year that a severe aerospace downturn 'turned', after several suppliers went bankrupt due to declining sales and high debt. No doubt a company that starts in the dark days of a recession like 2009 has a very low base and can show good results. Perhaps this is a really long cycle. I'm not sure it's not a cycle though.

 

[cmlber]

How are people comfortable with the extreme leverage that Transdigm uses? Under normal business conditions, the business is pretty robust. But what happens if airlines start parking planes in the desert and cannibalizing planes for spare parts (e.g. 9/11)?

 

EBITDA has grown every year since 1993 including 2001, and they have no near term debt maturities.

 

Thanks. Didn't realize they had financials available prior to the 2006 IPO.

 

They don't have full financials available, but they provide revenue and EBITDA as Defined for every year back to the founding in 1993 on each of the investor day presentations. 

 

Most of these parts are mandatory repairs.  The FAA has guidelines that essentially say "Once you've flown X miles, part A shall be replaced."  The options are ground the plane, or pay whatever price TDG asks. 

[Jurgis]

And I guess it's not easy to persuade FAA to accept replacement parts harvested from old planes...

 

 

With that said a large reduction of miles flown would hit TDG.

[KCLarkin]

They don't have full financials available, but they provide revenue and EBITDA as Defined for every year back to the founding in 1993 on each of the investor day presentations. 

 

Actually, full 10Ks seem to be available.

[cmlber]

And I guess it's not easy to persuade FAA to accept replacement parts harvested from old planes...

 

 

With that said a large reduction of miles flown would hit TDG.

 

There is a market for spare parts from parting out retired aircraft, but in order to do that, you need to scrap the plane.  No rational airline is going to scrap a functioning plane in a recession in order to save a few thousand dollars on parts.  So usage of surplus parts might increase slightly in a recession, but not dramatically.  And TDG would likely offset it with higher price increases and more opportunities for M&A.

[Jurgis]

Hmm, reading that, it seems that in good times airlines could be buying new planes and selling old ones to 3rd countries that may not buy TDG parts (or any parts for that matter). In bad times, the miles flown drop down, but new plane purchases also drop down, so TDG parts may be somewhat flattish (?depends I guess?).

 

There might be some risk that if TDG is hugely price gauging that airlines/US gov decide to bite the bullet and somehow certify other manufacturers. Not a high probability likely.

 

Edit: I still think that the risk of catastrophic failure with lives lost is something to consider. If this happens and TDG is shown to have skimped on QA/pushed subpar parts, this could blow it especially with the levered BS.

 

Disclosure: I have a very tiny position and do not plan to make it major position at this time.

[KCLarkin]

No rational airline is going to scrap a functioning plane in a recession in order to save a few thousand dollars on parts.

 

You wouldn't scrap an airplane just for TDG parts. But you might for the engines.

 

http://aviationweek.com/awin/spare-parts-pricing-and-availability-showing-volatility

How much longer will young aircraft fetch higher prices for their parts than as whole airplanes?

- Aviation Week 2012

 

But TDG might be insulated because the parts aren't worth the expense of recovering.

[hooplaer23]

Citron's report highlights a few examples of parts with dramatic increases in price after Transdigm acquires a company.  But does anyone have thoughts on what this price change is on average? 

 

I think you can back into an estimate based on assumptions on changes in margins.  Here's an example: a company has sales of $100 and EBITDA margins of 30%, so EBITDA of $30.  TDG acquires the company and raises prices, which I assume flows straight through to EBITDA.  So if TDG raised prices by 40%, and volumes stayed the same, sales would move to $140, and EBITDA would increase to $70, or 50% EBITDA margins, which is around TDG's corporate average.  And this example is not assuming any benefit from cost improvements, which TDG talks about making following an acquisition.

 

It's also worth pointing out that by at least one metric, the Producer Price Index by Industry: Aerospace Product and Parts Manufacturing https://fred.stlouisfed.org/series/PCU3364133641, over the last 10 years aerospace parts have gone up in price in the range of 20%. 

[fareastwarriors]

The Short Seller Who Crushed Valeant Has Picked His Next Target

 

https://www.bloomberg.com/news/articles/2017-02-01/stock-s-up-1-500-ceo-s-flush-and-andrew-left-sees-a-big-bubble

[Liberty]

Q4: http://www.transdigm.com/phoenix.zhtml?c=196053&p=irol-newsArticle&ID=2243578

 

Highlights for the first quarter include:

 

Net sales of $814.0 million, up 16.0% from $701.7 million;

Declared and paid a special dividend and related dividend equivalent payments of $1.36 billion, or $24.00 per share;

Net income of $118.9 million, down 8.2% from $129.4 million, primarily due to refinancing expenses;

Earnings per share of $0.41, down 81.6% from $2.23, primarily due to dividend equivalent payments and refinancing expenses;

EBITDA As Defined of $385.0 million, up 20.5% from $319.4 million;

Adjusted earnings per share of $2.57, up 13.2% from $2.27; and

Upward revision to fiscal 2017 financial guidance.

[Larry]

Subsequent to the fiscal quarter end, TransDigm repurchased 666,755 shares of its common stock at an aggregate cost of approximately $150.0 million under our existing stock repurchase program.

 

They repurchased ~1,2% of the company in just couple of weeks, looks like after the Citron short report. Their track record in repurchasing shares during dips has been great. Listening to the call right now.

[Guest Schwab711]

http://www.foxbusiness.com/politics/2017/02/17/trump-visits-boeing-sc-here-s-look-at-brand-new-dreamliner.html

 

Dreamliner 787-10 finally in production.

[Liberty]

$90m acquisition:

 

http://www.transdigm.com/phoenix.zhtml?c=196053&p=irol-newsArticle&ID=2248221

[Guest Schwab711]

$90m acquisition:

 

http://www.transdigm.com/phoenix.zhtml?c=196053&p=irol-newsArticle&ID=2248221

 

They keep adding to the Dreamliner bet. Their wiki article says sales up from €14m in 2005 to €43m in 2016 (11% CAGR). Takata acquired them for $32m in 2012.

https://de.wikipedia.org/wiki/Schroth_Safety_Products