TransDigm Group reports both FCF growth and cash in hand to acquire additional M&A targets. In my opinion, if the company comes up to the expectations of the markets, the share price will creep up. With a conservative DCF model that includes a WACC of 8.4%, in my opinion, the company’s total valuation is worth more than 23% of its current value. TransDigm Group also reports a significant amount of debt. However, the company invests in stable and predictable business models. I wouldn’t be worried that the company is not paying debt holders.
TransDigm Group Has A Private Equity Culture
Headquartered in Cleveland, Ohio, TD Group is a designer, producer, and supplier of engineered aircraft components:
Source: Transdigm
The company’s revenue comes from proprietary components. In 2020, 90% of the company’s net sales were generated by proprietary products. Most analysts usually expect more significant valuations from companies selling proprietary designs than from resellers. 44% of the company’s sales come from the defense industry, and 29% of the company’s sales come from original equipment manufacturers:
Source: Presentation
According to the company’s website, TransDigm Group has a private equity culture. The group acquires private companies at cheap valuations with financing obtained from the public markets. As a result, TransDigm owns a large number of entities, a substantial amount of debt, and goodwill:
Source: Transdigm
Balance Sheet: Cash, Goodwill, And A Lot Of Debt
I don’t think that we can obtain a lot of information from the balance sheet. What matters is whether the company signed beneficial deals with M&A targets. With that, it is worth noting that the company has a good amount of cash in hand. In my view, the company has sufficient financing to acquire more targets. As of April 3, 2021, the company reported $4 billion in cash with $8.5 billion in goodwill, and an asset/liability ratio of 0.8x.
Source: 10-Q
The total amount of long-term debt is equal to $19.4 billion. The leverage is quite significant. If we assume 2021 FCF of $1.679 billion, the company’s long-term debt is 11x. However, investors should not worry much about the company’s debt. TransDigm Group invests in companies showing stable EBITDA and significant EBITDA margin. It is likely that the targets will pay the debt:
Source: 10-Q
To calculate the WACC, I believe that readers will need to have a look at the following table. TransDigm Group pays a cost of debt close to 2.25%-7.5%. Besides, most of the company’s debt is payable from 2025 to 2027. From 2022 to 2025, I don’t think that investors will worry much about the debt obligations:
Source: Presentation
Source: Presentation
DCF Model Expects 2025 FCF of $3.3 billion And 24% 2025 Sales Growth
My sales forecasts include 2021 sales of $4.8 billion, 13%-14.5% sales growth, and CFO/Sales of 43%. My projections are a bit more conservative than that of other analysts. I also expect FCF generation; from $1.67 billion in 2021 to more than $3.3 billion in 2025:
Source: My Assumptions
Analysts over the internet believe that the company’s WACC is somewhere between 8% and 10.5%. The cost of equity is between 9.5% and 13%, and the cost of debt is 7%-7.4%. With these assumptions, I was comfortable using a WACC of 8.4%:
Source: WACC for TransDigm Group Incorporated (NYSE: TDG) | finbox.com
By summing the FCF from 2021 to 2025 and using a WACC of 8.4%, I obtained a sum of $9.76 billion. Notice that in 2021, there is a significant FCF growth of 51%, and the FCF growth is equal to 35% in 2022. Other analysts forecast the same FCF growth.
Source: My Assumptions
With a WACC of 8.4% and a terminal FCF of $3.44 billion, the terminal value equals $51 billion. If we subtract the net debt, the equity valuation is equal to $45.8 billion, which implies an equity per share of $800:
Source: My Assumptions
TransDigm’s current valuation is equal to $646 per share. With my target price of $800, I believe that the company’s share could be worth 23% more. Other analysts may make different assumptions concerning the WACC and the sales growth. However, I believe that most traders will be expecting that the company’s valuation is worth more than its current mark:
Source: TransDigm Group Incorporated (TDG) Stock Price Today, Quote & News | Seeking Alpha
Risks: Concentration Of Customers And Failed M&A Transactions
According to the company’s annual report, ten clients account for 44% of the company’s revenue. It is a large risk. If one of the customers decides to stop working with TransDigm Group, sales may decline significantly:
In fiscal year 2020, no customer individually accounted for 10% or more of the Company’s net sales; however, our top ten customers for fiscal year 2020 accounted for approximately 44% of our net sales. In the fiscal year 2019, one customer individually accounted for about 11% of the Company’s net sales. In the fiscal year 2018, two customers individually accounted for approximately 11% and 10% of the Company’s net sales. A material reduction in purchasing by one of our larger customers for any reason, including but not limited to economic downturn, decreased production, strike or resourcing, could have a material adverse effect on results of operations, financial position and cash flows. Source: 10-k
TransDigm Group bases its strategy on the acquisition of other companies. If TransDigm cannot find suitable M&A candidates, or the merger integration is not properly done, the company’s FCF may decline. As a result, I would expect the company’s valuation to diminish:
We intend to pursue acquisitions that we believe will present opportunities consistent with our overall business strategy. However, we may not be able to find suitable acquisition candidates to purchase or may be unable to acquire desired businesses or assets on economically acceptable terms or may be unable to receive necessary regulatory approvals or support. In addition, we may not be able to raise the capital necessary to fund future acquisitions. Because we may actively pursue a number of opportunities simultaneously, we may encounter unforeseen expenses, complications and delays, including regulatory complications or difficulties in employing sufficient staff and maintaining operational and management oversight. Source: 10-k
My Takeaway
Many analysts in the market believe that TransDigm Group will continue to acquire companies and report FCF growth. With a DCF model that includes a WACC of 8.4% and conservative FCF growth, the company appears undervalued. In my opinion, the company’s valuation could be worth more than 23%. If the company comes up to the market expectations in the coming years, I would be expecting additional share price growth.
Disclosure: We don’t hold shares
