Description

Business Profile:

TGI is a major aerospace supplier. Traditionally it’s very Boeing dependent (maybe a good thing right now), but is trying to diversify. They are extremely decentralized so there's A LOT of operating companies, product lines, aero programs, etc.

There are three business segments:

Aerostructures:         Makes large structural elements like wings, tails, fuselages, etc. This currently dominates revs and EBIT.

Systems:                     Makes mostly proprietary / sole source components. A huge range of products here. This is a structurally good business with above average growth.

MRO:                         A small business that engages in third party MRO activities. An okay business but not much growth.

Why the Stock is Cheap:

Triumph is probably the cheapest reasonable quality aero supply chain stock out there. After some major mishaps in the past 1.5 years, the stock trades for sub 12x guided current year adjusted earnings (back out pension income, and probably 12.5x). Still, this is several turns cheaper than the nearest comp barring SPR which is a perennial problem child. However, current investor sentiment drops both into the same bucket (both aerostructures, both execution issues)

Triumph suffers from three inter-related problems:

• Really bad execution on a 747-8 program, which was its biggest. This resulted in recurring charges and significant margin compression. The 747-8 program has been “right tracked” but currently produces zero margin after orders dropped.
• Exposed to lots of declining programs -- particularly several military programs and the 747 -- whereas most rivals are exposed to nicely growing programs
• Execution problems plus several "surprise" reductions / cancellations of various programs in the last year has shot to bits guidance given in 2012. This has resulted in a major credibility issue for management
• Their LT guidance is actually very rosy... but nobody believes it

Other sub problems include:

• Poor earnings quality and noisy financials. Strange acquisition related contract amortization that results in "fake" earnings, pension income, recurring charges that must be backed out etc. This can all be adjusted for but takes some work.
• Poor cash flow in the last several years. Lots of working capital and receivable days. Pension huge drag on FCF (over $100M of pension contributions per yr to top up the Vought pension plans)
• Low GAAP ROIC due to lots of acquisitions over the years plus poor execution on 747. Returns on tangible invested capital has been pretty healthy though.

Despite all this, I see promise.

The Thesis:

Most of Vought's problems date from their acquisition of Vought Aerospace. Vought gave them a huge exposure to Aerostructures, which is arguably the worst place in the aerospace supply chain. Plus, Vought was in a bunch of declining programs, and potentially was not a good executor. I don't know if they paid too much for Vought ex-ante (since overall valuation was reasonable, and there were some synergies), but clearly a few things have caught them by surprise in the last few years.

Triumph's track record of execution ex-Vought is decent. I see that except for a few years, organic growth rates were in the mid single digits or higher. And margins are reasonable.

So the bet is that, aside from the current execution / cyclical issues, this is a decent company.

There are a couple of pillars to the thesis:

Valuation

As mentioned, valuation is pretty low by almost any measure.

Free Cash

• Pension topups will end. As mentioned this was a HUGE drain in cash flow since the Vought acquisition.
• Some of the WC buildups are starting to reverse (see recent calls)
• They got a big one time payment from Eaton (ETN) this yr due to a recent legal settlement which is not even in the FCF guidance
• Look at their Q1 FCF and their full yr guidance. There’s over $330M coming in the door in the next few quarters, not including the Eaton settlement
• They’ve been building some WC related to large in-development programs for Embraer / Bombardier. These will at some point be turned into cash
• Bottom line is that even after factoring a rising cash tax rate 2 years out, this stock is trading for around ~8-9% FCF yield on a normalized basis.

Discrete Boost to Margin

• They have incurred significant costs (both capital and operating) in the past two years from the building of a huge new facility called Red Oak. They are moving a lot of production fromJefferson Street, a WWII era extremely inefficient facility. This will be a significant boost to margins in the next 2 years ($0.50 / sh net)
• Some interesting history here which I won’t go into. The company has plenty of info on the Jeffersonfacility and how massive and inefficient it was.
• In connection to the earlier point, this move is also positive for FCF
• Aftermarket sales in Systems (currently 20%) is a potential driver. A lot of component suppliers are pushing this, and I think TGI hasn’t done a great job historically. The CEO is making this a priority for the division. These sales produce huge incremental margins so even small progress here could have a material impact.

Positive Mix Shift

I think this is a really underappreciated point. The market lumps in TGI with “aerostructures” (SPR) but actually they have a large and growing Systems business. They recently broke out the program exposures for Systems vs. Aerostructures, and you can tell that the Systems programs are MUCH healthier. The backlogs are growing here whereas Aerostructures is probably shrinking.

In the next few years, this could drive a shift in investor narrative.

Program Shifts

It’s well understood that TGI’s next 18-24 months will be rough, mostly on aerostructures. 747 is still ramping down, and they are facing a big drop in 2016 for the C-17 program. C-17 will be a $0.50 drag to EPS. Plus, you have some weakness on military programs in general (e.g. Osprey), and they are not really exposed to the JSF program.

But, look beyond these two years and things look a lot better. I think Aerostructure can return to organic growth based on recent wins. Again, this is a driver of future narrative shift.

Capital Allocation and Activist

There’s a well respected activist, Atlantic Investment, in the name today. Alexander Roepers is flashy or go on CNBC but he produces results. (some of his VIC presentations are available). He’s known as a “gentleman activist” (not confrontational).

You can see this in the large buyback program TGI recently initiated. They have NEVER bought shares in size before. Needless to say, buying back 10%+ of the cap near today’s prices is good.

Conclusion

In today’s overheated markets, I think TGI is a pretty good risk/reward. I don’t see a ton of downside risk, and I see several avenues for earnings growth / multiple expansion in the next several years.

• Return to organic growth in Structures
• Mix shift towards Systems / Aftermarket
• Better FCF, ROIC, margins in general
• Hopefully regain mgmt credibility on the back of strong execution

Risks

• Further execution problems…
• Really stupid acquisitions (the last few have been pretty good, thankfully)
• Aero cycle issues

Catalyst