Jefferies Likes The Look Of Margin Expansion At TransDigm

Jefferies liked TransDigm Group Inc TDG shares for multiple reasons. The company is poised to deliver 20 percent growth in EPS compared to its rivals' growth of 10 percent driven by its proprietary product offering. The brokerage expects margin to expand 2.5 points a year to reach over 40 percent incremental margins.

Analysts Sheila Kahyaoglu and Howard Rubel listed three factors to back their thesis to initiate with a Buy rating and $340 target price.

The first factor is proprietary offering enabling it to command higher pricing thus expanding TransDigm margin. For every point of margin expansion, the brokerage expects $50 million additional revenue and $0.50 EPS.

In a note, analysts pointed out, "Price drives 65% of the earnings growth in our model. We have factored in margin expansion with Adjusted EBITDA margins rising from 45.5% in FY15 to 48.3% in FY20 (Ex. 25). TDG's 'core' EBITDA margins are in the high 40% range with acquisition margins ranging from 25-35%."

The second factor is more than the average growth prospects supported by targeted acquisitions and business model. Analyst expects organic revenue growth of 6 percent between 2017 and 2020 driven by four percent volume growth and the remaining from pricing. This is higher than the market trends of 3–4 percent.

The third factor is sole-source and consumable product offering since 55 percent of sales come from aftermarket revenues. Therefore, the brokerage listed four points to indicate that the company is well-placed.

• Proprietary and sole-source nature of offering
• Low ASP offering enables it to hike price
• Consumable product versus ‘repair' or ‘overhaul' based dispirits surplus or cannibalization parts
• Based on Free Cash Flow generation, acquisition could contribute 5 percent more to EPS

The brokerage cited risks coming from "sensitivity to air traffic demand, concentration to aerospace cycle, and limited visibility given short cycle business"