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Why Shares of TransDigm Gained 17% in May

By Lou Whiteman – Jun 3, 2020 at 5:14PM

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Commercial aerospace is in for a few tough quarters, but investors are beginning to warm to its long-term potential.

What happened

Shares of TransDigm Group (TDG -1.05%) jumped 17% in May, according to data provided by S&P Global Market Intelligence, as investors gained confidence the commercial aerospace component manufacturer can weather a COVID-19 related downturn.

Airlines have dramatically reduced their operations as a result of the pandemic, meaning fewer planes and less demand for spare parts. Given that commercial aerospace makes up about 65% of total TransDigm revenue, we knew the company would be affected, but after an initial panic earlier in the year that saw the shares lose more than half their value, the market is now warming to the stock again.

So what

As expected, TransDigm withdrew fiscal 2020 guidance early in the month, but the company did report better-than-expected earnings. Importantly, management did a good job articulating their plan to get through the crisis, and to grow once it is over.

About 80% of TransDigm's total costs are variable, meaning management has some flexibility to adjust spending based on demand. The company is assuming its aftermarket, or spare part, sales will decline by 70% to 80% and new equipment revenue to be down 25% to 40% for the next six months, but hopes to see signs of a recovery sooner.

An airplane taking off from a runway.

Image source: Getty Images.

The company does have more than $20 billion in total debt, but no maturities until 2025. That allows for a lot of flexibility to adjust to changing conditions.

By the end of the month, Wall Street was beginning to climb on board. On May 29, JP Morgan analyst Seth Seifman upgraded TransDigm to neutral from underweight, saying that although there are tough quarters ahead, TransDigm has a "proven track record" of value creation.

Now what

As Seifman notes, it is going to take time for a recovery to take hold. Commercial aerospace is looking at three years or longer until demand fully recovers, and it is going to be hard for any of these stocks to outperform until it does.

That said, TransDigm management remains convinced they can still generate software-like 40% margins through the downturn, and if a recovery starts to materialize sooner than expected, look for the company to be opportunistic in scouting out acquisition targets.

When a recovery does begin to take hold, it is likely to be felt by large aftermarket participants like TransDigm first because airlines loaded down with additional debt are unlikely to quickly commit to buying new aircraft. If so, there is reason to hope the worst is already over for TransDigm, and that the company's stock can continue to climb in the months to come.

Lou Whiteman owns shares of TransDigm Group. The Motley Fool owns shares of and recommends TransDigm Group. The Motley Fool has a disclosure policy.

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