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Morningstar | Where’s the Growth? TransDigm's Fiscal 3Q and 4Q Outlook Disappoints on Revenue Growth. See Updated Analyst Note from 07 Aug 2018

TransDigm reported fiscal third-quarter results that featured rising sales and profitability, but earnings missed consensus on the back of slowing organic growth. A modest guidance upgrade this quarter isn’t moving the needle on our valuation model--we were already at the high end of guidance--but our fair value estimate of $298 per share moved up $5 due to the time value of money. Nothing in the results changed our thesis that this wide-moat name will earn returns above its cost capital. However, we continue to believe shares look a bit expensive, and the deceleration in aftermarket growth gives us some concern. Shares are trading at a 15% premium to our new $303 fair value estimate.

Net sales increased 9.2% versus third-quarter fiscal 2016, reaching $981 million, as the Extant and Kirkhill acquisitions are now fully incorporated into results. Organic growth came in at 4.4%. While 4% plus organic growth compares favorably to the same period last year when organic growth stood at 3%, this quarter still represents a 220-basis-point deceleration from last quarter and most growth was from pricing not volume.

The commercial aftermarket drove a good portion of the sequential growth decrease, which grew a respectable 8% year over year this quarter but was down from 15% last quarter. The implied 6%-7% guide for fourth-quarter commercial aftermarket growth looks a bit light. The commercial aircraft equipment business remains subdued and registered only 1% growth this quarter due to wide-body demand, which is odd given the increasing 787 and A350 rates. Management blamed timing plus the 777 ramp-down, and we think the A330 might also be weighing on growth as well.

Management’s as-defined EBITDA measure came in at $487 million, representing a 49.7% margin and a 20-basis-point year-over-year contraction, as the Kirkhill and Extant acquisitions weigh on margins. Adjusted EPS increased roughly 19% to $4.01 with a significant portion of the increase coming from lower taxes.

In its business jet and helicopter end markets, which account for about 15% of the company's commercial revenue, TransDigm is finally seeing a rebound in both revenue and bookings. This comports with our view that the business jet market has bottomed and that we're going to see increasing aircraft deliveries toward the end of this year and into 2019. We also think the helicopter market is showing signs of a nascent recovery.

Defense is becoming a growing piece of TransDigm’s business mix with the percentage of total revenue related to defense hitting 35% this quarter up from 29% during the third quarter of fiscal 2015. Management reported solid growth out of the defense business this quarter and highlighted a book to bill above 1.0. However, orders can take 18-24 months to translate into revenue, which creates uncertain timing on when these bookings will impact financial results. Nonetheless, management's comments on growing demand in its defense end markets reflects our view that budgeted Department of Defense dollars are only beginning to translate into outlays to industry.

Turning back to the commercial business, TransDigm completed partnering for success negotiations with Boeing in July. Details are scant, but we believe that during this second round of partnering for success Boeing is focused not only on pricing but also on efficiency measures and on working capital items such as extending its supplier payment terms. TransDigm management doesn't anticipate the Boeing agreement to adversely impact the company's financial results.

Lastly, TransDigm has spent roughly $660 million on acquisitions this fiscal year and continues to hunt for more deals. However, should it not close more acquisitions, management anticipates $2 billion of cash on the balance sheet by end of this fiscal year (Sept. 30) and that this would most likely prompt a special dividend.