TDG is to airline industry as WAB to railways

I looked into TDG, TransDigm. I’ve done a comparative analysis against WAB, they are not in the same industry. WAB provide services to freight rail and passenger transit industries and TDG provides services and equipment to the airline industry.

TransDigm Inc. is a designer, producer and supplier of engineered aircraft components. The Components are used in commercial and military aircraft service. The Company operates in three segments: Power & Control, Airframe and Non-aviation. The Power & Control segment includes operations that develop, produce and market systems and components that provide power to or control power of the aircraft utilizing electronic, fluid, power and mechanical motion control technologies. The Airframe segment includes operations that develop, produce and market systems and components that are used in non-power airframe applications utilizing airframe and cabin structure technologies. The Non-aviation segment includes operations that develop, produce and market products for non-aviation markets.


**Revenue (Sales) in millions / %YOY**
         WAB      TDG    
2010 | 1507          827
2011 | 1968  30%    1206   45%
2012 | 2391  21%    1700   41%
2013 | 2566   7%    1924   13%
2014 | 3044  18%    2372   23%

**Diluted earnings per common share:**
        WAB      TDG*    
2010 | $1.28     2.52
2011 | $1.85     3.17
2012 | $2.60     5.97
2013 | $3.01     2.39
2014 | $3.62     3.16 

* The amount of net income or loss for the period per each share
in instances when basic and diluted earnings per share are the
same amount and reported as a single line item on the face of
the financial statements.

**Net Earnings in Millions (Revenue - COGS - Operating expenses) / %YOY**:
         WAB         TDG
2010 |   123         133
2011 |   170 / 38%   169 /  27%
2012 |   252 / 48%   321 /  90%
2013 |   292 / 16%   131 / -59%
2014 |   352 / 20%   180 /  37%

**Long Term Debt:**
         WAB     TDG
2011 |   395     3122
2012 |   317     3599
2013 |   450     5700
2014 |   525     7233

**Other stats:**
         WAB      TDG
Cash    425  M     819  M
Debt    521  M    7233  M
MktCap  9.14 B    11.53 B     
PE      26.20     65.03
                               WAB     TDG
Stock price on 01/08/2010 -   21.36    51.45   
Stock price on 05/01/2010 -   99.82   218.84
% Increase                -   367%    325%

New CFO:
http://www.transdigm.com/phoenix.zhtml?c=196053&p=irol-n…

TDG makes a lot of acquisitions. In 2015:
http://www.transdigm.com/phoenix.zhtml?c=196053&p=irol-n…
http://www.marketwatch.com/story/transdigm-acquires-the-aero…

CEO Nick Howley has been with TDG since 1998, CEO since 2003

  • They entered into a new long term employment contract with Nick Howley through 2019
  • Mr. Howley has a 2 year non-compete agreement upon termination or leaving

Lot of options granted to senior executives, but the options will be struck at market value, and they won’t vest unless long-term performance targets are met.

Dividend yield is really great.
special dividend of $22/per share in 2013 and $25 in 2014

Couple of concerns/questions:

  1. Is the stock currently overvalued, PE is 65.
  2. Large Debt, is it the nature of the business?
  3. High stock based compensation

Earning on May 5th.

I like what I’ve seen so far and am considering a small position.

Kris

6 Likes

Kris,

I took a look at the booming aerospace & defense sector a year ago with interest in TDG and two other companies, i.e., Spirit AeroSystems Holdings, Inc. (SPR) and Triumph Group, Inc. (TGI}. I’ll take a crack at some of your concerns/questions and use this as an opportunity for me to revisit and reassess these companies. I go back beyond 5 years to 2008 to include the financial/credit crisis period.

1. Is the stock currently overvalued, PE is 65.

Donning my value investor hat, I am most interested in first looking at a company’s cash flow and determining if the company is creating value.


	           **TDG	   SPR	   TGI**
**MARGINS**
**Gross %**			
2008	         54.07	 16.14	 28.56
2009	         56.38	 12.19	 29.24
2010	         57.16	 13.53	 28.39
2011	         54.82	 11.34	 23.18
2012	         55.62	  2.82	 24.73
2013	         54.54	 -1.65	 25.37
2014	         53.43	 16.00	 22.63
2015 (ttm)	 53.69	 16.45	 18.59
**Operating %**			
2008	         41.93	 10.78	 10.97
2009	         44.04	  7.44	 12.25
2010	         43.87	  8.56	 11.99
2011	         40.39	  7.32	 10.81
2012	         41.16	  1.71	  15.1
2013	         38.94	- 6.11	 14.35
2014	         39.10	  5.21	 10.63
2015 (ttm)	 39.41	  5.80	 10.01
**Profit %**			
2008	         18.65	  7.04	  5.84
2009	         21.39	  4.70	  7.09
2010	         19.75	  5.25	  5.23
2011	         14.27	  3.96	  5.16
2012	         19.11	  0.64	  8.24
2013	         15.73	-10.42	  8.03
2014	         12.93	  5.28	  5.48
2015 (ttm)       13.01	  5.68	  5.29
			
**ROIC**			
2007	         9.84%	19.63%	 7.25%
2008	        10.74%	16.51% -23.34%
2009	        11.34%	11.33%	 8.89%
2010	        11.49%	11.39%	 8.58%
2011	        11.33%	 8.91%	 9.92%
2012	        11.70%	10.05%	11.37%
2013	        10.97% -21.21%	10.89%
2014	        12.79%  20.91%	 7.39%
			
**05/01/15**			
**ROIC**	        13.27%  18.53%	 6.59%
**WACC**	         4.32%  12.95%	 6.02%
**EVA**	         8.95%	 5.58%	 0.57%
			
**P/E** (ttm)	 64.70	 20.30	 15.50
**Forward P/E** 	 22.62	 12.90	 10.11
**P/B** (mrq)	    NA	  4.00	  1.30
**P/S** (ttm)	  5.12	  1.07	  0.80
**P/FCF**	         21.10   52.00   10.60
**FCF/share**	$10.22	 $3.78	 $5.51
			
**Cash** (mrq)	 1.01B  377.9M  34.18M
**Total Debt**	 7.52B	 1.15B	 1.44B
**Debt/Equity**    -501.0%	 71.1%	 63.5%
**Current ratio**	  2.91	  2.42	  2.67
			
**Market Cap**	11.53B	 7.13B	 2.98B
52-wk high	226.21	 52.94	 72.31
5/1/15 PRICE	218.84	 51.36	 59.07
52-wk low	162.20	 31.49	 51.18

Notes: WACC is Weighted Average Cost of Capital; EVA is Economic Value Add (aka ROIC-WACC spread).

The table above shows that since 2008, among the three companies, TDG has the most potent combination, i.e., the most stable, strongest and highest margins (gross, operating and profit) coupled with a steady, consistently high Return of Invested Capital (ROIC).

On 5/1/15, TDG with a ROIC of 13% and a cost of capital (WACC) of 4% created 9 cents of pure economic value for every dollar invested. SPA created a nickel plus and TGI less than a penny. Notice that TDG created more value despite having a much higher P/E than SPR and TGI. Also, TDG’s Free Cash Flow per share is far above those for SPR and TGI.

For the sake of keeping my post short, take a look at this article, “Why TransDigm Group’s Earnings Are Outstanding,” that, although dated 2/26/13, still provides relevant cash flow analysis and considerations today.
http://www.fool.com/investing/general/2013/02/26/why-transdi…
Take note of these comments:

Adding stock-based compensation expense back to cash flows is questionable when a company hands out a lot of equity to employees and uses cash in later periods to buy back those shares.

Overall, the biggest drag on FCF also came from stock-based compensation and related tax benefits, which represented 9.6% of cash from operations.
My update: Stock-based compensation (aka “Non-cash equity compensation” in the TDG Cash Flow Statements) remains a large drag on FCF for fiscal years 2014, 2013 and 2012 at $26.3 million, $48.9 M and $22.2 M, respectively. I’ll comment more on this later in my post.

• Finally, the two most important points:
(1) Although business headlines still tout earnings numbers, many investors have moved past net earnings as a measure of a company’s economic output. That’s because earnings are very often less trustworthy than cash flow, since earnings are more open to manipulation based on dubious judgment calls.
Earnings’ unreliability is one of the reasons Foolish investors often flip straight past the income statement to check the cash flow statement. In general, by taking a close look at the cash moving in and out of the business, you can better understand whether the last batch of earnings brought money into the company, or merely disguised a cash gusher with a pretty headline.

(2) A Foolish final thought. Most investors don’t keep tabs on their companies’ cash flow. I think that’s a mistake. If you take the time to read past the headlines and crack a filing now and then, you’re in a much better position to spot potential trouble early. Better yet, you’ll improve your odds of finding the under appreciated home-run stocks that provide the market’s best returns.

As earslookin succinctly posted previously, paraphasing Warren Buffett: Growth rates, P/E, and PEG are attributes of value, not determinants of value. Here are some attributes.

 
	           **TDG	  %	  SPR	  %	  TGI	  %**
**Revenue $ M		Change		Change		Change**
2008	           714		3,772		1,151	
2009	           762	 6.7%	4,079	 8.1%	1,240	  7.7%
2010	           828	 8.7%	4,172	 2.3%	1,295	  4.4%
2011	         1,206	45.7%	4,864	16.6%	2,905	124.3%
2012	         1,700	41.0%	5,398	11.0%	3,408	 17.3%
2013	         1,924	13.2%	5,961	10.4%	3,703	  8.7%
2014	         2,373	23.3%	6,799	14.1%	3,763	  1.6%
2015 (ttm)	 2,430		6,813		3,745	
**Net Income $M**						
2008	           133		  265		   67	
2009	           163	22.6%	  192	-27.5%	   88	 31.3%
2010	           163	 0.0%	  219	 14.1%	   68	-22.7%
2011	           172	 5.5%	  192	-12.3%	  150	120.6%
2012	           325	89.0%	   35	-81.8%	  281	 87.3%
2013	           303	-6.8%	 -621		  297	  5.7%
2014	           307	 1.3%	  359		  206	-30.6%
2015 (ttm)	   316		  387    	  198	
**Diluted EPS**						
2008	          2.65		 1.91		 1.92	
2009	          3.10	 17.0%	 1.37	-28.3%	 2.65	 38.0%
2010	          2.52	-18.7%	 1.55	 13.1%	 2.04	-23.0%
2011	          3.17	 25.8%	 1.35	-12.9%	 3.16	 54.9%
2012	          5.97	 88.3%	 0.24	-82.2%	 5.41	 71.2%
2013	          2.39	-60.0%	-4.40		 5.67	  4.8%
2014	          3.16	 32.2%	 2.53		 3.91	-31.0%
2015 (ttm)	  3.37		 2.75		 3.79	

Most of TDG’s recent revenue growth can be attributed to what TDG calls “strategic” acquisitions. The purchases of Airborne Systems and Elektro-Metall were responsible for about three-quarters of TDG’s sales gains for Q1 2015. At the 1/27/15 Q1 Earnings Call, CEO Nick Howley related the following:

With respect to financial capacity, we have a little over $1 billion of cash, roughly $400 million in unrestricted undrawn revolver and additional capacity under our credit agreement. We ended the quarter with a net leverage of 5.9 times EIBTDA, well below our credit agreement limit. At 12/27/14, or the end of the quarter, based on current capital market conditions, we believe we have adequate capacity to make over $2 billion of acquisitions without issuing additional equity. This capacity grows as the year proceeds. This does not imply anything about acquisition opportunities or anticipated acquisition levels for 2015. We did not purchase any additional shares in Q1.
Subsequently, TDG pursued the following buys: Telair Cargo Group for $725 M; aerospace business of Franke Aquarotter for $75 million in cash; and the aerospace business of Pexco LLC for $496 million in cash.

2. Large Debt, is it the nature of the business?

TDG’s negative Debt/Equity ratio appears shocking when compared to SPR and TGI. Here’s what I’ve found for TDG:


          LT DEBT          EQUITY

2000     $ 1.77 B        $ 0.59 B
2011       3.14 B          0.81 B         
2012       3.62 B          1.22 B  
2013       5.73 B         (0.36 B)
2014       7.47 B         (1.55 B)

As mentioned above, TDG with positive cash flows is on an acquisition binge, leveraging at 5.9 times EIBTDA, which is aggressive. Since I’ve only taken a quick look, I need to dig further here. I usually can find explanations for a company’s capital strategy and debt management in their quarterly and annual reports, earnings call transcripts and investor presentations, but so far nothing for TDG.

3. High stock-based compensation

Thanks for bringing up this very important issue that is not unique for TDG. It’s an ongoing growing trend across corporate America that should alarm stock investors because companies are moving away from value creation to value extraction. TDG’s allocation of corporate profits to stock buybacks and those handsome dividends paid in 2013 and 2014 diminish the amount for investments in productive capabilities and higher wages for employees. My quick look at the capital deployment of TDG, SPR and TGI shows buybacks at the top of the list, followed by dividends, and next mergers & acquisitions as opportunities.

Here’s some food for thought - an informative comprehensive article on this issue in the Harvard Business Review, Septermber 2014, Profits Without Prosperity by William Laxonick.
https://hbr.org/2014/09/profits-without-prosperity

Five years after the official end of the Great Recession, corporate profits are high, and the stock market is booming. Yet most Americans are not sharing in the recovery. While the top 0.1% of income recipients—which include most of the highest-ranking corporate executives—reap almost all the income gains, good jobs keep disappearing, and new employment opportunities tend to be insecure and underpaid. Corporate profitability is not translating into widespread economic prosperity.
The allocation of corporate profits to stock buybacks deserves much of the blame. Consider the 449 companies in the S&P 500 index that were publicly listed from 2003 through 2012. During that period those companies used 54% of their earnings—a total of $2.4 trillion—to buy back their own stock, almost all through purchases on the open market. Dividends absorbed an additional 37% of their earnings. That left very little for investments in productive capabilities or higher incomes for employees.

The buyback wave has gotten so big, in fact, that even shareholders—the presumed beneficiaries of all this corporate largesse—are getting worried. “It concerns us that, in the wake of the financial crisis, many companies have shied away from investing in the future growth of their companies,” Laurence Fink, the chairman and CEO of BlackRock, the world’s largest asset manager, wrote in an open letter to corporate America in March. “Too many companies have cut capital expenditure and even increased debt to boost dividends and increase share buybacks.”
Why are such massive resources being devoted to stock repurchases? Corporate executives give several reasons, which I will discuss later. But none of them has close to the explanatory power of this simple truth: Stock-based instruments make up the majority of their pay, and in the short term buybacks drive up stock prices. In 2012 the 500 highest-paid executives named in proxy statements of U.S. public companies received, on average, $30.3 million each; 42% of their compensation came from stock options and 41% from stock awards. By increasing the demand for a company’s shares, open-market buybacks automatically lift its stock price, even if only temporarily, and can enable the company to hit quarterly earnings per share (EPS) targets.

As a result, the very people we rely on to make investments in the productive capabilities that will increase our shared prosperity are instead devoting most of their companies’ profits to uses that will increase their own prosperity—with unsurprising results. Even when adjusted for inflation, the compensation of top U.S. executives has doubled or tripled since the first half of the 1990s, when it was already widely viewed as excessive. Meanwhile, overall U.S. economic performance has faltered.

If the U.S. is to achieve growth that distributes income equitably and provides stable employment, government and business leaders must take steps to bring both stock buybacks and executive pay under control. The nation’s economic health depends on it.

The author calls for reforms to the system: (a) put an end to open-market buybacks; (b) rein in stock-based pay; and (c) transform the boards that determine excecutive compensation.

The Aerospace & Defense sector is experiencing an ongoing boom. My post focuses on TDG in response to the OP. The other two companies are back on keel and deserve a closer look, especially SPR that has realized a steady price gain of 63% over the recent 52-week period.

As always, conduct your own due diligence.

Regards,
Ray

12 Likes

Ray,

Thank’s for the detailed analysis, I had a quick glance but will take spend more time trying to digest your write up.

Also wanted to post this in case anyone else is following this:
http://newsletters.fool.com/18/coverage/updates/2015/05/04/c…

Kris

Ray,

I read your comprehensive analysis and looked through the numbers.
I don’t have much of a background on valuations, but am trying to learn, from Sauls FAQ, and reading posts. Your post gave me a solid exposure, thanks for laying it out so thoroughly. (BTW how did you compute all the % numbers, do you have some software that extracts these from edgar? if not, then it sure is a lot of work)

I noticed that although SPR has consistently higher revenue, its net income is less then TDG. My guess is that its operating costs are much higher?

As regards Stock-based compensation being a drag on FCF, I don’t see that improving any time soon. It seems like a lot of the executive staff have their stock based compensation. The plus side is they are incentivized to meet the performance targets, and this seems to be in place till 2019?

I took a small position right now.
The earnings will be out on 7th.

Regards,
Kris

1 Like

(BTW how did you compute all the % numbers, do you have some software that extracts these from edgar? if not, then it sure is a lot of work)

Not Ray. I copy and paste the financial statements from whatever online document they are provided on (earnings announcements, SEC filings) to a spreadsheet. After some cleaning up (quite PITA sometimes), I do the calculations.

Denny Schlesinger

Kris,

I ditto Denny’s comments.

Since I did my due diligence on these companies over a year ago, I already had most of the data on a saved computer spreadsheet and had to add only a few more years of data and calculations. Yes, it requires some effort, but it’s necessary since financial data and metrics provided at free and pay websites don’t always match up.

Regards,
Ray