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Overview

Transdigm Group Inc. (NYSE:TDG) reported positive 2012 second quarter results: its EPS of $1.65 beat estimates by $0.19 and the company generated revenues of $423M, which beat estimates by $33M. Overall, Transdigm has seen its stock increase 27.2% YTD and 51.5% from a year ago. There continues to be significant upside potential in the stock due not only to major industry catalysts but also to Transdim's strategic positioning of itself in the aerospace industry.

The Pros

Transdigm is $6.22B company that designs, supplies, and produces aircraft components that are used on nearly all commercial and military aircraft in service today. Transdigm greatly benefits from the fact that about 90% of its net sales are generated from its proprietary products. Moreover, about 75% of Transdigm's net sales are attributed to products for which Transdigm is the sole source provider. Transdigm has positioned itself so that its customers depend significantly on its products, many of which do not have direct competitors and dominate their respective consumer niches.

Another positive aspect of Transdigm is that a significant portion of its revenue, around 60%, is derived from its operations in the aftermarket sales industry. Aftermarket sales are orders for maintenance, overhaul, and retrofitting of already existing (and usually already operating) aircraft. These aftermarket sales generally provide Transdigm with high gross margins and are relative stable even in downturns. Moreover, there is an overall trend in the aftermarket industry of increasing demand. Airlines recently have begun to focus more on repairing and ensuring the logevity of their fleets as they start to recover from the adverse effects of the recession. As the airline industry slowly starts to turn a profit, airline companies not only have the funds to use for aftermarket purchases, but also continue to hold views of repairs as cost-effective alternatives to simply purchasing new aircraft.

Transdigm has shown repeatedly that it is aggressively expanding its operations and constantly searching for new avenues of profitability. Recently, in late January, Transdigm announced that it acquired AmSafe Global Holdings for $750M. AmSafe Global Holdings produces and sells highly engineered and proprietary safety and restraint equipment used primarily in the global aerospace industry. Moreover, its products are proprietary and certified and installed on more than 90% of the aircraft produced globally. With this acquisition, Transdigm expects a significantly positive impact on its bottom line; also it has stated it expects to receive substantial tax benefits starting in 2012 as a result of the transaction. This acquisition comes on the heels of Transdigm's November acquisition of Harco Laboratories for $84M.

The Cons

It is important to note that there are several negatives about Transdigm. For one, it has a stunningly high Debt/Equity Ratio of 385%, one which has only grown larger since I first covered Transdigm in November of 2011 (when it had a slightly lower, but still horrible, 299% D/E ratio). Transdigm's debt is in part a result of its expansion through acquisitions and could hinder Transdigm's ability to conduct future operations.

In Transdigm Group's 2012 2Q earnings call, the chairman and CEO of Transdigm, Nicholas Howley, noted that the company would most likely not be able to sustain the 25% YOY growth in its commercial market operations and also expressed uncertainties in Transdigm's defense operations. Military defense spending is notoriously hard to predict, especially in the current politically charged climate. Moreover, the defense markets comprise a significant portion (approximately 25%) of Transdigm's revenue, so any significant belt-tightening measures by the U.S. military will have a notably adverse effect on Transdigm. However, it should be noted that the AmSafe transaction occurred partly in response to this concern: AmSafe appealed to Transdigm because sales to the military didn't constitute a significant portion of its overall sales.

The Results

The strength of Transdigm's operations is reflected in its balance sheet. Its recently reported 2012 second quarter EPS figures are up 72% YOY and the average EPS growth of the company's last 3 quarters is a strong 59%. Moreover, its important to note that Transdigm's last three quarters also showed sequential acceleration in the rate of growth, a sign of Transdigm's ability to generate increasing revenues and leverage its assets for maximum returns. From a broader perspective, we can see that the strength of Transdigm's recent EPS figures is by no means an isolated occurrence: Transdigm's 3-Year EPS Growth Rate stands at a solid 20% and it has experienced 4 consecutive years of annual EPS Growth. This fiscal year, Transdigm's estimated annual earnings growth is expected to top 46.2%.

Sales figures for Transdigm's products paint a picture of consistently strong demand. Transdigm's recently reported second quarter sales increased 39% YOY; the company's 3-Year Sales Growth Rate is 25%. Transdigm's operations are also relatively profitable: its Annual Pre-Tax Margin is 29.9% and its Annual ROE is 34%.

The Verdict

Transdigm's solid financial performance and the strength of its operations have made it an attractive investment in the eyes of mutual funds: Transdigm has experienced 8 consecutive quarters of increasing fund ownership. In terms of analysts' opinions on Transdigm, 5 currently have a 'Strong Buy' on the company, 6 have issued a 'Buy' rating, and the other 8 have 'Hold' ratings on Transdigm; there are no 'Underperform' or 'Sell' recommendations for the company. Although there are certainly some negative aspects of Transdigm's operations and financials, overall it is a solid investment with significant potential.

Source: Transdigm: Solid Investment With Significant Potential