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TransDigm Inc and The Power of Pricing

About TransDigm Group:

TransDigm Group is a market-leading manufacturer of proprietary aerospace components, headquartered in Cleveland, Ohio. They focus on highly engineered aviation parts, operating in three specialized segments within the industry: power & control, airframe, and non-aviation. Their main customers include large original equipment manufacturers (OEMs) and defense contractors.

TransDigm utilizes a decentralized corporate structure, operating with lean management teams, and pushing responsibility down the chain. Management are proven excellent capital allocators and have strong shareholder alignment, resulting in a long-term focus on value creation and capital reinvestment that compounds at high rates of return.

Their competitive advantage lies within their valuable intangible assets with high barriers to entry, high switching costs complemented by a large and growing installed base, and efficient scale driven by capital intensity and their fortified and advantageous market positioning.

External Analysis:

The aerospace and defense supplier industry is characterized by three overarching themes: stability with moderate cyclicality, an increase in outsourcing to suppliers and high levels of fragmentation. TransDigm is well-positioned to take advantage of the future consolidation opportunities present and experience market share gains as a result.

Investment Thesis:

Economic moat drives pricing power and margin expansion

TransDigm operates in a defensible business with extremely high barriers to entry and a sticky customer base with growing amounts of recurring revenue. They possess strong pricing power due to an industry focus on quality over price, and their market positioning as the sole supplier of 70% of their products. The company focus has shifted to aftermarket sales that offer higher margins, allow for repeat sales, and create predictable and consistent cash flows to weather cyclicality.

Growing end markets increases demand for aircraft parts

Aircraft production will grow substantially, driven by rising global revenue passenger miles (RPMs), massive commercial backlogs, and expanding defense budgets. Projected increases in U.S. and non-NATO defense budgets drive strong demand for military equipment, increasing sales and long-term service contracts for TransDigm’s defense segment. This will increase both the volume of aircraft components demanded and the frequency of maintenance aircraft require.

Acquisition-focused growth strategy leads to dominant market positioning and sustainable value creation

Due to the fragmented nature of the supplier industry, TransDigm is able to create significant value by rolling up smaller suppliers via acquisitions. Large OEMs are facing pressure to cut costs and increase production, and are outsourcing more activities, increasing demand for suppliers. As OEMs grow, M&A consolidation will be encouraged up and down the supply chain, because there will be a reduced quantity of higher value contracts given to a select group of reliable suppliers. TransDigm has an established market position, a large and growing installed base, and scale advantages to benefit from future consolidation, to increase the volume and size of customer contracts.