So this is sort of a footnote to the previous post about a really great book.
(The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success. )
In chapter one (page 34), Thorndike mentions the TransDigm Group (TDG) as a contemporary analog for Capital Cities. TDG has grown cash flow at 25%/year since 1993 through internal growth and acquisitions (which Thorndike calls an “exceptionally effective acquisition program”). The approach is similar to Capital Cities in that they focus on businesses with exceptional economic characteristics.
The CEO responsible for this nice record, Nick Howley, is still the Chairman and CEO and is 60 years old (as of the 2013 proxy) so the story may still be intact; maybe it’s worth a look.
That’s a 33%/year performance since 2006. Pretty nice and consistent with the performance of other outsider CEOs. The book says TDG grew free cash flow +25/year since 1993.
Here are some figures for the last five years:
2007 2012 CAGR
Sales ($mn): 593 1,700 +23.5%
Operating income ($mn): 234 700 +24.5%
Adjusted EPS: $2.01 $6.67 +27.1%
EBITDA: $275 $809 +24.1%
These are pretty decent growth rates and the period includes the great recession.
What would one pay for a business that grew adjusted EPS at +27%/year in the past five years? The midpoint of the company guidance for 2013 is $6.80. With the current stock price trading at $143/share, that’s a P/E ratio of 21x. This may not be Graham and Dodd cheap, but with historical EPS growth of +27%/year and a company goal of growing 15-20%/year (in equity value), 21x may not be expensive at all, not to mention that free cash flow is much higher than adjusted earnings. If we use 55% of current year expected EBITDA as free cash flow (see later slide), we would get $8.93/share in free cash flow per share and a multiple of 16x free cash; not bad for a company growing so quickly.
Some of the components included (or excluded) in the “adjusted” earnings and EBITDA may be debatable, but I’m not trying to pinpoint an exact valuation here; just getting a general sense of the company.
Unlike the many outsider companies, TDG has a great investor relations website with some interesting slides (see here).
By the way, one thing we have to look at later is that current year adjusted EPS guidance is $6.80 (at midpoint) versus $6.67 in 2012. I haven’t dug into this to see if the growth period for TDG is over, or if it’s a short term thing (EPS was also flat in 2010, so this may be lumpier than your typical ‘growth’ stock).
Management/directors own just over 10% of the shares, but Howley doesn’t own much except for what he gets from options (which only vest with performance). Howley owned just under 5% at the time of the IPO but hasn’t owned much since except for the options.
Berkshire Fund VII (Private equity, not the Buffett entity!) owns 7.6%, and Lone Pine Capital owns 6.7% (as of the 2013 proxy). It looks like they sold some shares but still own 2.6 million shares as of the August 13F. Lone Pine Capital is run by the highly successful Stephen Mandel, a Tiger cub (ex-Tiger Management). Tiger cubs are known to do a lot of work (analysis) on their holdings.
Also, I noticed that Tiger Global, also a high performing Tiger cub bought some shares this year which indicates that TDG might still represent some value. Tiger Global owned a large stake for a while but didn’t own any shares (according to the 13F) earlier this year until some shares showed up on the 13F in August. It’s only 530,000 shares or so compared to their 4.5 million shares they owned back in 2008. TDG didn’t show up in the 13F as far back as late 2011, so maybe this is seller’s remorse. In any case, it’s a datapoint for whatever it’s worth. Tiger cubs are generally very fundamentally based investors who focus a lot on management so it’s a good sign that they are shareholders.
Anyway, let’s take a look at some slides.
First I’ll snip some stuff out of the 2012 Analyst Day presentation:
TDG makes and sells aftermarket products for the aerospace industry. It is apparently a high-moat business since not just anyone can make stuff and sell it to people who put them in planes. They are highly engineered and government approved (for safety etc…), which usually takes time and money to do.
The private equity-like business model is their dependence on acquisitions for part of their growth. They typically pay 9-11x EBITDA and through efficiencies, get the effective EBITDA multiple down by more than 50%.
Here’s a very long term view of their results, going back to their founding in 1993 (actually, the following two charts are from the September 2013 investor presentation as they have updated figures):
It’s good to know that TDG continued to grow even after EBITDA margins got into the 40s in the early-to-mid 2000s. So EBITDA margin improvement from 20% in 1993 to 47% in 2013 is not the whole story; TDG has grown substantially even since 2004 when margins hit 46%.
They operate in a growing industry, so this is not rolling up local yellow pages or anything like that:
I think there is no doubt that the aviation industry is growing over the long term:
High moat businesses:
Sole source means they are the only ones that can replace a part.
Kind of Berkshire-like (or outsider-like) localization:
Performance based pay:
Clearly defined objective:
…and way to achieve it:
Plenty of room for more acquisitions:
As Munger says, what you don’t do is just as important (or more important) than what you do:
And of course, what’s the point without free cash?
Well, this is just a quick first look but it is certainly pretty interesting. It’s trading at 21x current adjusted P/E and 16x free cash flow (assuming free cash is 55% of EBITDA this year), which is not a bad valuation if they continue to grow in their target range of 15-20%.
I have yet to dig into the filings, conference call transcripts and annual reports going back, but there is plenty of interesting things here to make this worth at least a closer look. I haven’t followed this company at all so I don’t have a comfort level with this as much as the other companies I post about, but the fact that it came out of the outsider book and has Tiger cub shareholders (even though one of them may be on their way out) gives me more comfort than a random idea I read about on the internet.
The immediate concern, I suppose, would be to get a sense of why things are slowing so much in 2013; a year that doesn’t look so bad.
Earnings for the FY 2013 (which ended in September) should be out soon and maybe we can get some more clarity on the outlook for next year.
Other concerns are obviously how long Howley will stay on, how size may become a problem going forward etc.
As usual, if I find anything interesting to add, I will make a followup post to this.