TransDigm pushes forward despite stock drop, activist attention

A turbulent patch for TransDigm Group Inc. (TDG) continued Monday as the company provided an outlook for fiscal 2017 that was softer than what analysts had expected. Given Dan Loeb's share ownership, it was perhaps not surprising that company execs spent considerable time during their conference call laying out the long-term case for the aerospace supplier.

Cleveland-based TransDigm reported adjusted fourth quarter earnings of $3.29 per share, beating analyst estimates, on weaker-than-expected revenue. But the company also said to expect 2017 earnings per share that was about 7% below what analysts had expected, including interest expense, taxes, and other non-operations items, on sales that were projected to be 1% to 2% below what was expected.

The company stressed that it was attempting to be extremely conservative in its guidance, with chairman and CEO W. Nicholas Howley saying that he is cautious as far out as 2018 because the commercial aerospace cycle "seems long in the tooth to me." But shareholders on Monday were not in a patient mood, sending shares down more than 6% in mid-afternoon trading.

TransDigm has ample reason to be looking over its shoulder, with noted activist Loeb owning about 2% of shares as of Sept. 30 via Third Point LLC. But Howley on the call said he remains committed to the long-haul and is a believer in TransDigm's strategy, which includes a decentralized collection of aerospace assets that Howley says gives shareholders "private equity-like returns with the liquidity of public markets."

The company over the years has been a prolific dealmaker, growing from an enterprise value of about $400 million 16 years ago to a current $23 billion and doing more than 50 acquisitions in the process. In the past three years alone the company did nine deals worth a combined $3.3 billion, buying mostly smaller bolt-on assets that have attractive characteristics like strong aftermarket components and are poised for future growth, while also returning about $3.2 billion to shareholders via dividends and buybacks.

Specifically, Howley noted that about 90% of TransDigm's revenue comes from proprietary products where it has a strong competitive advantage, and about 36% of sales come from the commercial aftermarket that figures to hold up well even if the surge in new-plane sales does eventually come to an end. The company's guidance reflects that balance, with TransDigm predicting aftermarket revenue will be up in the mid to high single-digit percentage rate in 2017, new-plane business up but growing at a smaller rate and defense revenue flat to slightly up.

TransDigm earlier in the fall declared a special dividend of up to $1.5 billion financed in part by new borrowings. The company even after the stock price decline is relatively rich compared to other suppliers and it had about $10 billion in debt as of Sept. 30, making an activist-pushed sale seemingly unlikely, but an investor could push for the company to consolidate its operations or jettison certain assets.

Howley did not mention Third Point or activism on the call, but said that the company's capital allocation strategy was unchanged. He said that the company currently has the capacity to do about $1 billion in acquisitions without issuing equity, and said that thanks to free cash flow that capacity figures to grow to nearly $2 billion as the year goes on.

He said that TransDigm's priority is to invest in existing businesses and do deals, with returning cash to shareholders likely if the company is unable to find suitable targets. The M&A pipeline according to Howley is "reasonably active," consisting mostly of small to mid-sized targets.

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