Concept: Commercial OE Play Trading at a Defense Multiple
In March 2010, Triumph ("TGI") acquired Vought (owned by Carlyle) in a transaction that essentially doubled the size of the company from $1.3Bn in revenues to $3Bn+ in revenues. The deal was valued at 5.8x EV/EBITDA (low valuation vs most comm. aero transactions at 9-10x due to significant Vought pension liability). Pro forma for the transaction, Triumph's end market exposure will be 50% commercial, 36% military, and 14% business jet/non-aviation/regional jet. In addition, pro forma Triumph is 75-80% OE (original equipment) and 20-25% aftermarket. The deal was structured as 53% cash and 47% stock and Carlyle now owns 1/3 of the shares outstanding post the deal. The deal closed on 6/15/2010 and Carlyle has a one year lockup and has 3 of the 9 board seats.
At $90, TGI is currently trading at 10.6x and 8.7x my FY12 and FY13 (March year end) EPS estimates. One should view FY12 and FY13 as CY11 and CY11 given the March fiscal year end. This compares to comm. aero peers trading at 15x CY11 P/E and pure play defense names trading at 9-10x CY11 P/E. In short, TGI is essentially trading at a defense multiple despite high exposure to commercial OE cycle which is expected to grow 15-20%+ over the next 2 years given healthy backlogs at both Boeing and Airbus despite Boeing's well documented delays w/ the 787 (less than 1% of TGI's revenues). When I last spoke to Triumph in late November, they stated that Boeing had not asked them to slow down production which is consistent with my dialogues with other suppliers. Below are historical and projected financials:
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TGI Undervalued and Poised for 20-25% EPS Growth: With commercial aero names such as Goodrich, Boeing, Precision Castparts, Transdigm, BE Aerospace trading at 15x+ CY11 P/E, TGI is relatively and absolutely undervalued given my expectation for 20-25% EPS growth for the next 2 years which will be driven by higher commercial OE production rates, a recovery in aftermarket, and realization of publicly stated cost synergies of $15MM (increased from $8-10MM from announcement of deal)
While I recognize that TGI is not as high quality a business as Transdigm or BE Aerospace as these businesses have higher exposure to aftermarket, strong market share and higher returns and margins, I see no reason why TGI should not trade at 12-13x which is essentially an average of the multiples that Goodrich (~17x) and Spirit (11x) trade at
Street Numbers Too Low: After going through each of the top 10 platforms for TGI and reading the end market growth expectations from the suppliers (Goodrich, Transdigm, Rockwell Collins, BE Aerospace, etc), I recently met w/ the CFO and Treasurer to walk through what EPS could be for FY12 and I walked away with confidence that TGI will likely do 10-11% better than Street expectations for FY12 (CY11)
While TGI wouldn't give me dollar content on each platform, I did some back of the envelope estimates of expectations for production rates for each of their platforms and estimated that their commercial OE business should be able to grow 18-20% over the next 2-3 yrs (this is consistent w/ Goodrich's guidance of 15-20% expectations for commercial OE growth in CY11) - CFO told me that 15-20% wasn't unreasonable to assume for growth
CFO told me that defense would be flat/slightly down and biz jet would be flat (consistent w/ my conversations with BE Aerospace and other suppliers)
When I backed into their pro forma revenues for FY11 and put in a blended 6% growth rate for FY12 (conservative blend of their end markets) I estimated that their FY12 revenues could be in the $3.5Bn area. CFO said my math made sense
When I layer on incremental margins of 10-20% and add $15MM of cost synergies, I said implied EBITDA of ~$530MM. Stripping out $108MM of D&A (run-rate of $27MM from last quarter which CFO said was decent run-rate for FY12), implies EBIT of $422MM vs Street at $390MM. When I put in my estimates for tax and interest and 25MM FDS share count, I said that I got ~$8.50 for next yr EPS (or 11% above Street at $7.67). CFO said that he wasn't going to comment on my number but that I wasn't missing anything (pension expense will likely will be down in FY12 which I'm not modeling)
Interestingly, the CFO believes they can achieve $50MM cost synergies over the next 3 yrs
As a way to stress test my number, I looked backed at TGI's presentation when they announced the Vought transaction and for FY12, TGI believed on a pro forma basis they could do $517MM in EBITDA in FY12. Since then, TGI has increased cost synergies from $8-10MM to $15MM and Boeing has increased production rates for 737 and 777 while the outlook for aftermarket has improved. CFO conceded that this $517MM EBITDA number has an upward bias but he wouldn't comment beyond that as it would be close to be providing guidance (Street at $506MM).
Catalysts Will be Continued EPS Beats and Upward Bias of FY12 Numbers: The catalyst for the stock will be continued EPS beats. Street is modeling $6.40 EPS vs mgmt guidance of $6.60 which assumes zero synergies. When I pressed the CFO if they had realized cost synergies last quarter, he conceded they had realized ~$1MM of cost synergies and he expected this number to ramp up each quarter.
My 12 month price target is $125 which is a 12x multiple on my FY13 EPS of $10.41.
Integration of Vought could be more challenging than expected
Vought has been much more integrated while Triumph has run a much more decentralized operation. The bear case out there (when you strip out Carlyle, roughly 11% of shares are short) is that eventually the Vought transaction is blow-up. TGI concedes they are still a "show me" story
Boeing could continue to delay production/deliveries
Downside - $80
Should slower than expected deliveries occur or cost synergies take longer to realize, I think downside EPS for FY12 is ~$8 and struggle to see why TGI should trade at a defense multiple of 9x given high (50%+) exposure to the commercial OE cycle which is the one area within commercial aerospace where most suppliers believe they have visibility (the slope of the aftermarket recovery is difficult to predict). Putting a 10x multiple on a $8 number, I get $80
If you are concerned about headline/multiple risk tied to Boeing (40% of TGI's pro forma revenues), I'd recommend a pair trade of going long TGI and shorting BA
Upside - $125
12x my $10.41 FY13 EPS number or $125. In short I think the risk/reward is 3:1 for TGI and like it at current levels w/ catalysts in the form of EPS beats and an upward bias to Street FY12 number
Continued EPS beats and upward bias to FY12 Street numbers