May they all go as TransDigm goes

I’ll preface this by saying the last thing in the world I want to do is sit down and write about quarterly earnings reports. What a drag. But special companies demand special circumstances. And TransDigm and I, by now, are in a long-term relationship.

This isn’t a recommendation. I don’t know if you should buy this stock. Frankly, you should probably just buy a bunch of Vanguard funds and go have fun. I am not adding to my own position at this time, and wouldn’t want to imply otherwise.

TransDigm Group makes airplane parts. Some for military planes. Some for commercial planes. Some spare parts for planes already in the sky. Some for planes that are just being built.

It should be a commoditized business, squeezed by the manufacturers and end customers. Indeed, by in large the value in manufacturing isn’t in the widget maker, but rather in the system integrator/end assembly company that dreams up the designs, puts it all together, and farms out the parts to the lowest bidder.

TransDigm beat expectations for its fiscal first quarter, both for earnings and sales. It also lifted its guidance for the full fiscal year. And the CEO said, “we could see further upward revision” to guidance based on China reopening and continued pent up demand from the American traveler.

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TransDigm is no normal company. It has routinely over the past decade posted software-like margins (north of 45%!) in a commoditized business. It is a rollup of sorts, an assembly of different bolt-on acquisitions run under the umbrella of a small office headquarters in Cleveland that acts more like a private equity firm than it does a manufacturer.

Past performance is not indicative of future success. But boy that past performance…

The company’s secret sauce is it focuses on parts that are both rare, and necessary. Rare parts are not easy to commoditize because there is no need for mass production. But if they are the difference between an aircraft taking flight with fare-paying passengers or remaining grounded, airlines will pay through the nose. Most of TransDigm’s products are either patent-protected, or rare and necessary. A significant percentage of its costs are variable, and can be swung higher or lower based on demand.

Post-earnings management says it sees vigorous demand from all markets, both commercial and defense and new and spare parts. Defense, just over 40% of sales, has lagged since the start of COVID but appears to be playing catchup. The model is still working.

I’ve been hearing for a decade about how those margins are not sustainable. (They held up during the pandemic, the ultimate test for anyone on commercial aerospace.) I’ve been hearing for a decade about TransDigm’s high debt load, a product of its private equity-like model. There are still few maturities on the near-term horizon, and management expects its net debt as a percentage of EBITDA to fall to 5x, from 6x, by later this year. If so, the company has ~$9 billion or so to throw at M&A in a volatile, uncertain market where valuations are under pressure, or could return cash to shareholders in a one-time dividend.

And yet TransDigm trades at a huge discount to Heico, its closest comparison, in terms of enterprise value/earnings. 18x vs nearly 30x.

I can’t tell you whether TransDigm goes up or down from here. I don’t know if you should buy the shares. (Again, I am not adding here.) It is a boring old aerospace company and there are new worries on the horizon as fleets modernize and the law of big numbers begins to creep in. But this is one people always ask me about, and Twitter is a poor medium to reply. So doing it this way instead. Ask your doctor if TransDigm shares are right for you.

I can tell you it has been one hellova last decade for TransDigm. Whatever stocks you find to invest in, may they all go as TransDigm has gone.

Disclaimer: Fits and Starts DOES NOT provide financial advice. All content is for informational purposes only. Stocks mentioned are as reference only, and a mention should not be interpreted as a buy or sell recommendation. The author is not a registered advisor or a broker/dealer. DO YOUR OWN HOMEWORK. The information contained within is not and should not be construed as investment advice, and does not purport to be.

No statement or expression of opinion, or any other matter herein, directly or indirectly, is an offer or the solicitation of an offer to buy or sell the securities or financial instruments mentioned.