Description

Wrangler’s writeup from March of 2020 does a good job laying out an overview of the business, so we will not rehash much of that here.

The reason to like TDG’s business is the Aftermarket component (both commercial and defense, but we’ll focus here on commercial). Commercial AM is less than 1/3 of TDG’s revenues and AM accounts for the majority of EBITDA. Per the Q422 earnings slides:

Price & Volume

Because most of TDG’s revenues are from proprietary parts, threat of competition and substitution is low, enabling significant pricing power.

Maintenance and replacement parts are a very small percentage of an airline’s overall cost structure, meaning significant price changes in TDG’s parts does not meaningfully impact their customer’s overall costs.

Historically TDG has taken price low-mid single digits on average, and the company says they generally try to price ahead of CPI. (Q3 2022 Earnings Call)

This pricing behavior has continued in recent years, despite COVID. It has also continued in recent quarters when CPI has been elevated, which means TDG could increase price by HSD/LDD.

The impact of pricing actions in the last few years has been hidden by the sharp drop in volumes, which of course began in early 2020. Volumes (as approximated by revenue passenger kilometers) went to nearly zero, and have still not yet rebounded to pre-covid levels, as seen here:

The impact of this volume recovery should be very significant on the business, as if/when volumes do recover to 2019 levels, TDG’s revenue should be much higher than 2019 levels given the compounding of years of price increases. This should lead to expanding margins as well, given the very high incremental margins from price increases.

In addition, the company has taken costs out of the business. Total headcount at FYE2022 was more than 20% below 2019 levels (per the company’s 2019 & 2022 10Ks).

Fleet Age

The global aircraft fleet is meaningfully older now than it was in 2019. This has been driven by a few factors, including supply chain problems at OEMs, and the reintroduction of planes that had been parked given the COVID-driven volume declines. Almost 18% of the current fleet is parked as of January 2023:

Given the same amount of flight activity, aftermarket part intensity should be higher in an older fleet (as more planes are outside of initial warranty windows), providing additional volume upside for TDG. The fleet aging is seen here:

Capital Allocation

TDG’s management team has historically been extraordinary at allocating capital. The two main uses have been M&A, where the track record is stellar, and special dividends.

In FY 22, behavior changed a bit, and the company started to meaningfully repurchase shares. In its previous 15+ years as a public company, TDG had bought back less than $800m of stock in total. In Q2 and Q3 of FY 22, they bought back $912 million at an average price of $612.13 per share (pg 22 of 2022 10K).

The company says these repurchases are expected to meet its underwriting targets like any other capital investment, which implies that they believe the return profile in the coming years can be very compelling.

Many investors are probably aware of this, but the 50X podcast episodes on TDG and associated resources (https://www.50xpodcast.com/episodes/) are informative. This chart lays out the steady-state algorithm for growth in value at TDG – it seems that the pricing dynamics in the AM recovery would provide a tailwind to these numbers. 

Expectations and Outlook

It appears from consensus expectations that the outlook for margin expansion is not much different than history, as consensus EBITDA margins are only expected to grow from 48.7% to 51.1% from FY22 to FY25. This is not much different than the company’s steady-state goal of gaining ~100bps annually in operating leverage, implying little consideration for the power of compounded pricing flowing through.

Key risks include macro uncertainty or other public health crises leading to lower air travel demand, rising rates reducing cash generation for a highly levered business, and an eventually increasing mix of OEM revenues which are positive long-term but margin dilutive in the short-term.

This was written before the company’s Q1 FY23 earnings call, but the report appears to be confirmatory of this thesis. We especially note the quote from Kevin Stein in the earnings press release: "We are raising our full year guidance primarily to reflect our strong first quarter results and current expectations for the remainder of the fiscal year. As our fiscal 2023 progresses, should the favorable trends in the commercial aerospace market recovery continue, including the expansion of flight activity in China, we could see further upward revision to our guidance."

Disclaimer

The views and opinions stated are the personal views of the author. Do not rely on the information set forth in this write-up as the basis upon which you make an investment decision – please do your own work. The author and funds in which the author manages hold positions in and trade, from time to time, securities issued by TDG and options on such securities.  This write-up does not purport to be complete on the topics addressed, and the author takes no responsibility to update this write-up in the future.  This is not a recommendation to buy or sell any securities.

Catalyst

Continued air traffic recovery