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Weitz Funds - A Perspective on TransDigm Group
Posted by: Canadian Value (IP Logged)
Date: October 23, 2013 09:38PM
Analyst Corner: A Perspective on TransDigm Group
September 30, 2013
By David Perkins, CFA
TransDigm (TDG) develops, manufactures and sells niche aerospace components, including valves, pumps, sensors, motors, batteries, faucets, seatbelts and latching systems for commercial and military aircraft. The company’s product line-up is proprietary, vast (tens of thousands of SKUs) and diverse (50+ product lines). Its products are installed on almost all of the major commercial platforms currently in production globally, with an estimated installed base of over 70,000 commercial transport, regional transport, military and general aviation fixed wing turbine and rotary wing aircraft. TransDigm generates the bulk of its profits from selling replacement, or “aftermarket,” components.
Another pillar of TransDigm’s business has been its ability to consistently raise prices at rates exceeding inflation. On average over the last 20 years, we estimate TransDigm has realized a roughly 5% annual increase in the selling price of its components. Importantly, pricing gains have been relatively uniform across its portfolio over time. TDG’s biggest selling SKU is less than 1% of total sales, so no single product or group of products is responsible for the increase. We think TransDigm’s demonstrated ability to increase prices will continue, and believe the combination of rising traffic and price in TDG’s core commercial aftermarket business will continue to generate attractive organic growth well into the future.
Helicopter Ben? We Prefer Airplane Nick
We have a lot of respect for TransDigm’s co-founder, Chairman and CEO Nick Howley. He and the board have instilled an ownership culture and maintained and executed a disciplined acquisition strategy that has created significant wealth for shareholders. TransDigm’s business generates prodigious excess cash flow, which management has deployed principally in two ways: 1) through the purchase of additional “proprietary aerospace businesses with significant aftermarket content,” or 2) via the payment of special dividends to its owners. TDG has largely pursued the latter course when it has been unable to find acquisitions that clear its stringent qualitative and financial hurdles, and has paid a total of $42.50 per share in special dividends over the past 5 years.
We like lumpy, opportunistic M&A stories led by operationally and financially savvy management teams, as few hitters see six or seven consecutive batting practice fastballs. When TransDigm came public in 2006, 90% of sales came from proprietary products and 75% came from components with sole-source positioning. Fast forwarding 7 years and 29 acquisitions later, those two key variables remain unchanged. You won’t find “de-worsification” at TransDigm. As well, we estimate management has earned in the neighborhood of 15% after-tax returns on the roughly $2.7 billion of capital it has deployed over that time frame, handily exceeding its cost of capital. Looking forward, TransDigm still has significant opportunity to continue to acquire high quality, niche aftermarket aerospace platforms. In the event it cannot, TDG’s stated intention is to continue to stamp out solid organic growth, re-lever its balance sheet, and return excess cash flow to shareholders with a goal of producing mid-teens annual total returns. We are pleased to own this very attractive business, managed by a high caliber team, at a healthy discount to our $175-$180 value estimate.
Guru Discussed: Wallace Weitz: Current Portfolio, Stock Picks
Stocks Discussed: TDG,