That winning streak came crashing to a halt in 2020, with TransDigm shares down more than 40% year to date due to the COVID-19 pandemic and its impact on the airline industry. Airlines that just months ago were in expansion mode are now grounding jets and cutting costs, putting pressure on new jet sales and the aftermarket, or spare parts, business.
Commercial aerospace makes up about 65% of total TransDigm revenue, and we knew going into its quarterly earnings release the company would take a hit. Here is a look at the results, and what management had to say about the months to come.
Making the best of a bad situation
On May 5, TransDigm reported fiscal second-quarter adjusted earnings of $5.10 per share on revenue of $1.44 billion, compared to analyst expectations for $4.36 per share in earnings on revenue of $1.45 billion. The quarter ended on March 28, meaning conditions likely got a lot worse in the weeks that followed.
The company is a favorite among investors because of its ability to generate software-like margins. About 90% of net sales are from proprietary products, and 75% come from products where TransDigm is the sole source provider. That gives TransDigm pricing power, and helped the company post an EBITDA margin of 46.8% for the quarter, down 170 basis points year over year, but still well above industry averages.
TransDigm was already thinking about a slowdown prior to the pandemic. Company officials said they were worried about how long the commercial aerospace production cycle was going to last back in January, highlighting signs of Pacific Rim air travel slowing, and were adjusting spending plans down ahead of the virus.
Nearly 80% of TransDigm's total costs are variable, meaning management has some flexibility to adjust spending based on demand. About half of all company spending is on inputs, either raw materials or payments to subcontractors, and about one-third of total spending is tied to labor. Last month TransDigm said it was cutting its total workforce by up to 15% and slashing executive pay.
Don't expect it to be enough to preserve those gaudy margin numbers through the worst of the near-term slowdown, but management is hopeful that as the pandemic fades and travel begins to normalize even at reduced levels, margins can bounce back quickly.
TransDigm has the cash it needs to survive
TransDigm added to its debt load in April, borrowing an additional $1.5 billion. On a post-earnings call with investors, company co-founder and executive chairman Nicholas Howley called the added funds "an insurance policy for these uncertain times." TransDigm's cash balance as of March 28 was $4.2 billion, and while the company does have more than $20 billion in debt, it has no maturities until 2025.
"It's quite unlikely we need it," Howley said of the cash raise. "The only way you get in trouble here is if the situation becomes much worse than anyone expects and you run out of fuel or cash. We're filling our tanks as full as we can at a reasonable price."
If he is right, the extra cash could eventually go toward acquisitions. TransDigm has used dozens of deals over the past two decades to amass its collection of aerospace component offerings. Howley said "we will tend to be fairly cautious until the smoke clears," but said TransDigm remains on the lookout for deals.
"We're probably a little more skeptical on any valuation that someone would come up with," Howley said. "But we're not shut down."
A rebound could take time
TransDigm has pulled full-year guidance, but the company is assuming aftermarket revenue declines of 70% to 80% and new equipment revenue to be down 25% to 40% for the next six months. That's hopefully conservative, especially on the aftermarket side, as airlines are likely to use their existing fleets instead of buying new jets if they are able to slowly restore flights.
Even if airlines do rebound quickly it is nearly impossible to know how quickly part sales will follow. There's little visibility into how many unused parts were in customer inventories at the time of the schedule drawdowns.
And older jets, the ones most likely to be retired permanently, tended to be "slightly" more profitable platforms for TransDigm. CEO Kevin Stein said TransDigm is doing its best to monitor conditions and react accordingly.
We just need to keep watching. The best thing you can use to analyze the market is the order stream coming in. And that's what we need to follow closely and ensure we're getting ahead of the cost side as well as where there's opportunity for additional sales where there's opportunity both on the defense and in the commercial space. There are still opportunities that you need to capitalize on.
Don't bail on TransDigm
TransDigm is a well-run business, and for years now it has been the first stock I would recommend to anyone seeking exposure to the aerospace industry. Times have obviously changed, and TransDigm has a challenging road ahead of it. But even with the pandemic, I see no reason for shareholders to run for the exits.
The company is doing what it needs to do to make it through the downcycle, and if aftermarket sales do return faster than new equipment, it will likely see a rebound faster than the two to three year downturn Boeing is forecasting for new equipment sales.
For investors looking to put new money to work in commercial aerospace, there are other companies, namely Heico, that appear well positioned to bounce back faster. But I still believe TransDigm is a long-term winner.