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TransDigm Down to Underperform

Zacks Equity Research

On Sep 25, 2013, we downgraded aircraft components maker, TransDigm Group Incorporated (TDG), to Underperform based on the company’s debt burden, higher interest expense and lowered net income and earnings guidance.

Why the Downgrade?

Estimates for TransDigm, which focuses on the aerospace industry, have been declining ever since it reported third quarter results on Aug 7. TransDigm’s third quarter revenues as well as Non-GAAP earnings of $488.6 million and $1.89 per share surpassed the Zacks Consensus Estimates of $486 million and $1.70, respectively.

However, GAAP net income came in at $76.7 million, down 15.2% year over year. GAAP earnings were 71 cents per share, down 57.7% from $1.68 in the prior-year quarter. The reduction in year-over-year earnings was mainly due to non-cash compensation cost related to the accelerated vesting of 2.4 million stock options and higher interest payments.

Further, due to the additional interest burden related to $1.4 billion of new debt raised, TransDigm has lowered its earnings guidance. EPS is expected to be in the range of $2.28 to $2.40 per share (down from the previously guided range of $5.29 to $5.51) due to increase in the number of outstanding shares in the next quarter. Adjusted earnings per share are expected to be in the range of $6.74 to $6.86, down from $6.83 to $7.05 projected earlier.

Following the release of the third quarter results, the Zacks Consensus Estimate for 2013 has gone down significantly by 55% to $2.42 per share. The Zacks Consensus Estimate for 2014 has also declined 5.4% to $6.89 per share. In addition, fourth quarter estimates were down from earnings of $1.77 a share to a loss of 16 cents a share.

With the Zacks Consensus Estimates for the fourth quarter of 2013, 2013 and 2014 going down, the company now has a Zacks #4 Rank (Sell).

Cause for Concern

On Jul 5, the board of directors of TransDigm approved a special dividend of $22 per share, which was a robust increase of almost 71.2% from its last payout of $12.85 – a special dividend paid last November. In order to fund this payout, the company had raised $1.4 billion in July, which further pressurized its interest expense that was already high.

Further, with about three to four acquisitions on board, it might take some time for TransDigm to properly integrate them into its existing business. Thus, the acquisitions may not be immediately accretive.

Thus, the company mentioned that its bottom line might get affected because of this high expense.

Aerospace Stocks That Warrant a Look

While we prefer to avoid TransDigm until we see signs of improvement in the company's performance, other aerospace stocks worth a look are Alliant Tech Systems Inc. (ATK) and Elbit Systems, Ltd. (ESLT). Both are Zacks #1 Rank (Strong Buy) stocks. AAR Corp. (AIR) is also worth considering given its Zacks Rank #2 (Buy).

Read the Full Research Report on TDGRead the Full Research Report on AIRRead the Full Research Report on ATKRead the Full Research Report on ESLTZacks Investment Research