Fitch Affirms TransDigm's IDR at 'B'; Outlook Stable

NEW YORK--(BUSINESS WIRE)--

Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDR) of TransDigm Group, Inc. TDG and its indirect subsidiary TransDigm Inc. (TDI) at 'B'. Fitch has also affirmed the ratings of TDI's senior secured credit facilities at 'BB/RR1' and TDI's senior subordinated notes at 'B-/RR5'. The Rating Outlook is Stable. Fitch's ratings cover approximately $10.1 billion of outstanding debt. A full list of rating actions follows at the end of this release.

The Recovery Ratings and notching in the debt structure reflect Fitch's recovery expectations under a scenario in which distressed enterprise value is allocated to the various debt classes. TDI's capital structure includes senior secured credit facilities and senior subordinated notes. The expected recovery rating for the senior secured credit facilities is 'RR1', indicating recovery prospects in the range of 91% to 100%. The senior subordinated notes are at the 'RR5' level, which reflects an expected recovery in the 11% - 30% range.

KEY RATING DRIVERS

The ratings are supported by the company's strong FCF, good liquidity, strong margins, healthy commercial aerospace markets, higher U.S. defense spending, and a favorable debt maturity schedule. TDG has good diversification in its portfolio of products that supports a variety of commercial and military platforms/programs, and it is a sole source provider for the majority of its sales.

Fitch's concerns include the company's high leverage, declining interest coverage, the long-term cash deployment strategy which focuses on acquisitions and occasional debt-funded special dividends, and weak collateral support for the secured bank facility in terms of asset coverage. Additionally, Fitch notes that TDG is exposed to the cyclicality of the aerospace industry, as it reported several quarters of organic sales declines during fiscal 2009 and 2010 driven by lower demand for aftermarket parts and production cuts by commercial original equipment manufacturers (OEMs). The market cyclicality is somewhat mitigated by growth from acquisitions, high margins, and sales diversification.

TDG generates significant cash flows due to its ability to demand a premium for its products, partially driven by a large percentage of sales from a relatively stable and highly profitable aftermarket business; low research and development costs; and low capital expenditures. Additionally, TDG's cash flows benefit from the lack of material pension liabilities and no other post-employment benefit (OPEB) obligations.

The company's leverage metrics have been stable over the past several years, as leverage has remained in the range of 6x to 7.5x. Fitch expects the company will continue managing its capital structure with leverage in the range of 6.5x to 7.5x going forward. Fitch expects TDG's leverage will be at 7.3x by the end of fiscal 2016 after giving effect to the recent incremental borrowings consisting of $950 million of senior subordinated notes and $950 million in senior secured term loans issued in connection with the purchase of the stock of ILC Holdings, Inc., the parent company to Data Device Corporation (DDC). Fitch believes DDC will be a good business fit with TDG's existing businesses, because approximately 70% of DDC's revenue is generated from aftermarket sales, and substantially all products are proprietary and sole-source. TDG completed the acquisition on June 23, 2016.

Fitch expects leverage to decline to approximately 7x by the end of fiscal 2017. Even though TDG's leverage metrics have stabilized, the company's coverage ratios have steadily deteriorated as FFO interest coverage declined to 2.5x at the end of 2015 from 3.2x at the end of 2012. TGD's ratio of operating EBITDA-to-gross interest expense declined to 3x, down from 4x during the same period. Fitch anticipates a continued deterioration of coverage ratios due to expected increase in indebtedness and corresponding rise of cash interest expenses.

Fitch believes TDG has the capacity to make approximately $500 million of acquisitions per annum with internally generated cash; however, a larger acquisition would likely require debt financing. Fitch views TDG's projected metrics as consistent with the 'B' Long-Term IDR, but the level of support for this rating has been reduced by the new leverage paradigm.

The ratings are also supported by positive trends in most of the company's end markets. The Large Commercial Aircraft (LCA) market continues to be in an upturn, which is driving record backlogs and higher deliveries of LCA worldwide. Both LCA manufacturers are currently experiencing a record operating environment in terms of backlog and deliveries. The large order book, overbooked delivery slots, and geographic diversity support the outlook for continued modest growth.

The fiscal 2015 U.S. defense budget hit a trough (base budget and wartime spending), and it began rising in fiscal 2016. Fitch still considers the defense outlook to be somewhat uncertain, partly due to the Pentagon's intense focus on lowering costs, which could impact the sector's profitability, as well as the continued risk of sequestration after fiscal 2017.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for TDG include:

--Leverage will remain in the range of 6.5x to 7.5x over the next several years;

--The company will issue additional debt over the next three years, offsetting expected growth in EBITDA;

--Excess cash will be paid to shareholders in the form of special dividends if the company does not make acquisitions;

--Revenues will grow by approximately 17% in both fiscal 2016 and in fiscal 2017. The growth will slow to low double-digits thereafter driven by acquisitions and anticipated growth of the aerospace and defense sector;

--Margins will remain in the range of 44% to 46% over the rating horizon;

--The company will maintain long-term cash balances in the range of $500 million to $700 million.

RATING SENSITIVITIES

Fitch does not anticipate positive rating actions in the near term given current credit metrics and the company's cash deployment strategies. Positive rating actions could be considered if the company modifies its cash deployment strategy and focuses on debt reduction.

A negative rating action may be considered if there is significant cash flow margin erosion without commensurate de-leveraging of the company. Additionally, Fitch may consider a negative rating action should TDG's leverage (debt-to-EBITDA) and FFO adjusted leverage increase and remain between 8x to 8.25x and above 9.5x, respectively, driven by weakening of the global economy, a downturn in the aerospace sector, or by issuance of additional debt to fund special dividends or acquisitions.

LIQUIDITY

The string of recent acquisitions should allow TDG to accelerate its revenue, EBITDA and FCF growth over the next several years. TDG has adequate financial flexibility and good liquidity supported by a $600 million revolving credit facility and a sizable cash balance, as the company typically holds above $500 million in cash. As of April 2, 2016, TDG held $612 million in cash and equivalents. The company does not have significant debt maturities until 2020 when $500 million of senior subordinated notes become due and the $1.2 billion tranche C of its credit facility matures. Fitch anticipates the company will refinance the maturing debt and estimates TDG's liquidity will fluctuate between $1 billion to $1.5 billion over the next several years.

FULL LIST OF RATING ACTIONS

TransDigm Group, Inc.

--Long-term IDR at 'B'.

TransDigm Inc.

--IDR at 'B';

--Senior secured revolving credit facility 'BB/RR1';

--Senior secured term loans at 'BB/RR1';

--Senior subordinated notes at 'B-/RR5'.

The Rating Outlook is Stable.

Date of Relevant Rating Committee: July 28, 2016.

Summary of Financial Statement Adjustments - Fitch has made no material adjustments that are not disclosed within the company's public filings.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1009720

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1009720

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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