Capital Allocation Snapshot: TransDigm

TranDigm (TDG) is a company that is similar to another company I profiled, HEICO. Both are FinTwit favorites, both are known for making many acquisitions of niche aerospace companies. TransDigm is a $49B market cap company that produces a wide range of aircraft components. In this Capital Allocation Snapshot, I’ll take a look at TranDigm’s cash flow statement to get a high level overview of how the company reinvests their profits.

Cash Flow Summary

Summarizing TranDigm’s cash flow statement is the first step to see how they allocate capital. Looking at the past five years, TDG has averaged about $1B in cash from operations. This figure has been steady, but also not growing.

TranDigm’s cash from investing has some big swings. The figures for 2018 and 2021-22 show the company spending around $700M on investments. For 2020, the company received cash of nearly $800M from investments. Then back in 2019, the company spent a whopping $4B investments. In the next section we’ll take a closer look to see what all the company is investing in.

Cash from financing also has some big swings. The year 2021 was an outlier with on $70M spent on financing. In 2018 and 2019, TransDigm spent about $1.1B on financing. Then in 2019 and 2022 the TDG increased their financing spend to $2.2B.

With so much cash coming in going each year, I like to look at the cumulative change in cash to see if the company is building cash reserves or losing cash. Over the past 5 years, TransDigm cash balance has dropped by about $500M.

Cash from Investing

One of the main areas of capital allocation is how much the company spends on capital expenditures. TransDigm’s capex has hovered around $100M over the last five years. This level of capex is about 10% of the company’s cash from operations, which means TDG does not require a large amount of cash to maintain its manufacturing facilities. With TransDigm being a manufacturer, I would have expected their level of capex to be a bit higher. A counter point may be that TDG does not need to expand their manufacturing facilities since they expand through acquisition instead of building a new factory to increase production.

The next line item is the acquisition of business, which is a major focus area of TDG. In most years, TransDigm does a pretty sizable acquisition. The purchases in 2022 represent about 40% of TDGs cash from operations, 2018 was about 67%, and 2021s acquisition was over 100% of cash from operations. Then in 2019, the company spent a large sum of nearly $4B, which was 4x their operating cash flow. The outlier year was 2020, where TDG made no purchases.

TransDigm focuses on buying small aircraft parts suppliers, so it is a niche they have much experience with. Serial acquirers can be good companies to invest in provided the management is paying reasonable prices for the purchased businesses. However, many times corporate managements make bad acquisitions that burn shareholder wealth. In order to gauge how well TranDigm’s management is doing with acquisitions, further research would need to be done on their deals.

Interestingly, TDG not only buys company, but also sells some of their subsidiaries each year. The biggest sale came in 2020 at $900, which gave the company a cash boost since that was the one year they did not buy any companies. In 2019 and 2021, TransDigm received around $200M from selling business. Then in the other two years of the series, TDG received smaller sums in sales. It is impossible to tell just from these numbers if TranDigm is making a profit from selling these business, so that is another homework item.

Cash from Financing

Jumping to the financing section of TranDigm’s cash flow statement, we see their use of debt. From 2018 to 2020 the company increased their debt load by around $8B. The peak increase in debt was 2019 at $3.9B, which almost matches the amount TDG spent in acquisitions that year. It is interesting that TransDigm added $3B in debt in 2020, but they made no large acquisitions that year. In the last two years, TDG has paid down their debt by a couple hundred million.

To put TransDigm’s debt issuance into perspective, it is good to look at the common leverage ratios. Usually I would look at the long-term debt to equity ratio of a company, but that figure is useless for TDG since the company has negative equity. The negative equity value seems to come from negative retained earnings, which is odd since the company has generated positive net income for quite a while. The other common leverage ratio is the long-term debt to EBITDA. For TransDigm, this figure comes in at 7.2, which is very high. A ratio above 3 is considered pretty high, and private equity, which is known for its heavy debt use often uses around 5x debt to EBITDA.

Next is TransDigm’s repurchase of equity. For most of the last 5 years TDG has practically bought back zero stock. That changed in 2022 when they spent $900M in buybacks. This figure is almost as much as their cash flow from operations that year. Seeing how the company spent $400M in acquisitions and $1B in dividends in 2022, this buy back wasn’t just a thing to do with leftover profits for the year. It would be good to take a look at TranDigm’s stock price during 2022 to see if they bought back their shares at a good price.

Finally, we have TranDigm’s dividend payout. TDG does not pay a steady, slowly increasing dividend like most companies. Instead, they barely paid any dividend in 2018 and 2021. For the years 2019, 2020, and 2022, TransDigm’s dividends as a percentage of cash from operations was about 168%, 158%, and 116% respectively. These payout ratios are very high, and mean TransDigm is funding their shareholder returns by using debt. Maybe when interest rates are low, it makes some sense to take on cheap debt and return cash to shareholders with buybacks and dividends. I personally do not care too much for this practice because it seems short sighted since it does not work if interest rates rise, and the extra debt puts the company in a more fragile position.

Conclusion

The main levers TranDigm is using with their capital allocation is acquisition of businesses, and shareholder returns. The company has a high payout ratio when it does pay a dividend, but their dividend seems to be more opportunistic than steady. The large share buyback in 2022 also seems opportunistic since TDG has not bought much shares in the other four years. This large amount of cash being returned to shareholders, as well as the sizable acquisitions are being partially funded by taking on debt. The company is known for being a public company that uses the private equity strategy of making many acquisitions using a lot of leverage. In order to feel comfortable owning TransDigm, I would need to spend more time looking at how consistent their profits are in order to maintain their debt load.