MRO Magazine

Fitch Upgrades TransDigm’s Sr Subordinated Debt to ‘B-/RR5’; Outlook Revised to Stable


May 11, 2015
By Business Wire News

NEW YORK

Fitch Ratings has affirmed the Issuer Default Rating of TransDigm Group, Inc. (NYSE:TDG) and its indirect subsidiary TransDigm Inc. (TDI) at ‘B’. Fitch has also affirmed the ratings for TDI’s senior secured credit facilities at ‘BB/RR1’ and upgraded the rating of TDI’s senior subordinated notes to ‘B-/RR5’ from ‘CCC+/RR6’. Approximately $8.2 billion of debt will covered by the ratings after giving effect to recently announced transactions, including the issuance of approximately $900 million of debt. The Rating Outlook is revised to Stable from Negative.

The newly issued debt consists of a $450 million term loan under TDI’s senior secured credit facilities and $450 million of senior subordinated notes maturing in 2025. Fitch expects the proceeds will be used to repay currently outstanding amounts under the revolving facility and to finance the recently announced $496 million acquisition of Pexco LLC. The remaining proceeds will be used to replenish company cash balances which were depleted over the past two quarters for two other acquisitions.

KEY RATING DRIVERS

The one-notch upgrade of TDI’s senior subordinated notes is driven by Fitch’s expectations of better recovery prospects for this class of securities in a theoretical financial distress scenario. The recovery prospects of the senior subordinated notes are positively affected by pro forma EBITDA projections following the recent acquisition and Fitch’s revised expectations of the company’s sustainable EBITDA under the distress scenario. Fitch estimates the Recovery Rating for the senior subordinated notes is ‘RR5’ (recovery in the range of 11%-30%), up from ‘RR6’ (recovery in the range of 0%-10%).

The revision to Stable from Negative is driven by the stabilization of the company’s leverage metrics over the past several years. While TDG’s leverage is high for the ‘B’ rating category, Fitch believes that leverage provides only a partial indication of TDG’s credit profile, which also benefits from its business model, high EBITDA margins (44% in fiscal 2014), and strong free cash generation before special dividends (21% of sales in fiscal 2014). Prior to fiscal 2013, TDG’s leverage ranged from 4.5x to 6x. The company experienced significant increases in leverage in both fiscal 2013 and fiscal 2014 when it utilized debt to fund special dividends. Over the past seven quarters, the company’s leverage has remained in the range of 6x to 7.5x. Fitch estimates this could rise to up to 7.6x immediately following the completion of the announced debt actions, up from approximately 7.1x at Dec. 31, 2014. Fitch expects leverage will remain within the range of 6.5x to 7.5x over the foreseeable future.

The ratings are supported by the company’s strong free cash flow (FCF; cash from operations less capital expenditures and dividends), good liquidity, strong commercial aerospace markets, stabilizing U.S. defense spending, and a favorable debt maturity schedule. TDG has good diversification in its portfolio of products that support a variety of commercial and military platforms/programs, and it is a sole source provider for the majority of its sales.

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 payment of three debt-funded special dividends in fiscal 2013 and fiscal 2014 resulted in a diminished ability to de-lever rapidly; however, the streak of recent acquisitions should allow TDG to accelerate its revenue and EBITDA growth over the next several years, improving its financial flexibility. Fitch believes TDG has the capacity to make approximately $600 million of acquisitions per annum beginning fiscal 2015 with internally generated cash; however, a larger acquisition would likely require debt financing.

TDG has adequate financial flexibility and good liquidity supported by a $420 million revolving credit facility and a sizable cash balance as the company typically holds above $500 million in cash. The liquidity will improve slightly following a completion of the proposed increase of the revolving credit facility to $500 million from $420 million. The company does not have a significant maturity until 2017 when $500 million of senior subordinated notes become due. Fitch anticipates the company will refinance the notes and estimates TDG’s liquidity will fluctuate between $800 million to $1.5 billion over the next several years.

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

Fitch expects TDG will have robust aftermarket sales supported by high aircraft utilization and the continuing increase in worldwide revenue passenger miles. Additionally, the fiscal 2015 U.S. defense budget likely hit a trough (base budget and wartime spending), and it should begin rising in fiscal 2016, even under the scenario in which the Sequester is not overridden.

Fitch’s concerns include the company’s high leverage, its long-term cash deployment strategy which focuses on acquisitions, 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 by production cuts by commercial original equipment manufacturers (OEMs). The market cyclicality is somewhat mitigated by growth from acquisitions, high margins, and sales diversification.

KEY ASSUMPTIONS

Fitch’s key assumptions within the rating case for the issuer include:

–The company will not make additional acquisitions and the capital structure will remain unchanged for the remainder of fiscal 2015;

–After fiscal 2015 TDG will spend at least $500 million annually on acquisitions, which can be financed by internally generated cash;

–Revenues will grow by approximately 14% in fiscal 2016 and 5% thereafter driven by anticipated growth of the aerospace and defense sector and acquisitions;

–Margins will rebound in fiscal 2016 and will be more in line with the company’s historical levels;

–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;

–Cash balances will be maintained 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 the weakening of the global economy, a downturn in the aerospace sector, or by issuance of additional debt to fund special dividends or acquisitions.

Fitch takes the following rating actions:

TDG

–Long-term IDR affirmed at ‘B’.

TDI

–IDR affirmed at ‘B’;

–Senior secured revolving credit facility affirmed at ‘BB/RR1’;

–Senior secured term loans affirmed at ‘BB/RR1’;

–Senior subordinated notes upgraded to ‘B-/RR5’ from ‘CCC+/RR6’.

The Rating Outlook is revised to Stable from Negative.

Additional information is available at ‘www.fitchratings.com

Applicable Criteria and Related Research:

–‘2015 Outlook: Global Aerospace and Defense’ (Dec. 17, 2014);

–‘TransDigm Group – Ratings Navigator’ (Dec. 8, 2014);

–‘Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage’ (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

TransDigm Group – Ratings Navigator

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=830208

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=984442

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Fitch Ratings, New York
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