Oct 16 – Fitch Ratings has assigned a ‘B-/RR5’ rating to $550 million of
senior subordinated notes due 2020 issued by TransDigm, Inc. (TDI), an indirect
subsidiary of TransDigm Group Inc. (NYSE: TDG). Fitch Ratings also assigns an
‘BB/RR1’ rating to $150 million of senior secured term loans, which is an add-on
to the company’s existing term loans. Approximately $4.3 billion of outstanding
debt is covered by Fitch’s ratings. A full list of ratings follows at the end of
this release.
The company expects to use the majority of the proceeds from the issued debt to
fund a $450 million to $850 million special dividend to its shareholders, make
cash dividend equivalent payments under its stock option plans, and for general
corporate purposes. Following the debt issuance, Fitch estimates TDG’s leverage
increased to approximately 5.9 times (x) from approximately 4.9x as of June 30,
2012. The increased leverage is in line with the company’s historic leverage
which typically fluctuates between approximately 4.5x and 6.0x, occasionally
reaching higher than 7.0x.
TDG’s ratings are supported by the company’s strong free cash flow (FCF: cash
from operations less capital expenditures and dividends), good liquidity, and
financial flexibility which includes a favorable debt maturity schedule.
TDG benefits from high profit margins and low capital expenditures,
diversification of its portfolio of products which support a variety of
commercial and military platforms/programs, a large percentage of sales from a
relatively stable aftermarket business, its role as a sole source provider for
the majority of its sales, and management’s history of successful acquisitions
and subsequent integration. Fitch also notes that TDG does not have material
pension liabilities and has no other post-employment benefit (OPEB) obligations.
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 is
concerned with the risks to core defense spending after fiscal 2012; however,
this risk is mitigated by TDG’s relatively low exposure to the defense budget
and by a highly diversified and program-agnostic product portfolio.
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). While market cyclicality is
somewhat mitigated by growth from acquisitions, high margins and sales
diversification to the defense sector, the expected decline in defense spending
coupled with a possible downturn may result in lower FCF.
The Recovery Ratings and notching in the debt structure reflect Fitch’s recovery
expectations under a scenario in which distressed enterprise value is allocated
to the various debt classes. The expected recovery for bank-debt holders remains
‘RR1’, indicating recovery of 91% – 100%. The senior subordinated notes are
‘RR5’ which reflects an expectation of recovery in the 11% – 30% range.
At the end of fiscal 2011, TDG’s leverage was approximately 5.6x, up from 5.0x
at the end of fiscal 2010. TDG’s leverage increased significantly following the
acquisition of McKechnie Aerospace Holdings Inc. (MAH) at the beginning of
fiscal 2011, reaching above 7.0x immediately after the MAH acquisition. The
company’s leverage receded to approximately 4.9x as of June 30, 2012. As of June
30, 2012 TDG had debt of $3.6 billion, up from $3.1 billion at Sept. 30, 2011.
TDG’s leverage is somewhat high for the rating; however, it is mitigated by
strong margins and positive FCF generation. Fitch projects TDG’s leverage to
fluctuate between the historic range of 4.5x to 6.0x.
At June, 30, 2012, TDG’s liquidity consisted of $303 million in cash and $303
million available under its revolver ($610 million less $7 million in letters of
credit), partially offset by $20.5 million in current amortization payments
under the $2.05 million term loan. Year-over-year, TDG’s liquidity decreased by
$180 million, mostly due to a decline in cash which was used to make several
acquisitions during fiscal 2012. TDG does not have major maturities until 2017.
Fitch expects TDG to maintain a solid liquidity position in fiscal 2012 and
2013.
Excluding a special dividend paid to shareholders in 2010, TDG generated nearly
$200 million annual FCF over the past four years. In fiscal 2011, FCF totaled
$239 million, up from negative $220 million in fiscal 2010. The negative FCF in
2010 was primarily due to the large one-time dividend payment., the most relevant part of the budget for defense
contractors, is down 4%, the third consecutive annual decline by Fitch’s
calculations.
The overhang of potential automatic cuts beginning in early 2013 related to the
‘sequestration’ situation, as well as the presidential election, add to the
uncertainty faced by defense contractors in the current environment. The U.S.
defense outlook will be uncertain and volatile over the next one to two years,
and program details will be needed to evaluate the full effect on TDG’s credit
profile.
On Sept. 14, 2012, the Office of Management and Budget issued a Sequestration
Transparency Act report detailing the potential impact of sequestration on
funding reductions for both defense and nondefense budget accounts. The report
assessed that unless the sequestration law is changed, the DoD budget will be
cut by approximately $52 billion in FY2013. Budget cuts to Modernization
Spending would be expected to account for approximately $23 billion or nearly
44% of the cuts despite comprising only 29% of the total DoD budget. The
majority of the remaining cuts will be in the Operations and Maintenance
account. Should sequestration occur the cuts in Modernization Spending could be
partly mitigated by low outlay rates during the first year for the majority of
Procurement and R&D; programs.
Fitch would not expect sequestration-driven DoD spending declines alone to lead
to negative rating actions for TDG. The company has a relatively limited
exposure to DoD spending and it is mitigated by good liquidity and the
diversification of its product line.
FUTURE RATING ACTIONS
Fitch is unlikely to consider a positive rating action in the near future given
TDG’s current leverage and the increase of its senior secured and senior
subordinated debt. A negative rating action may be considered should TDG
complete another acquisition financed by debt or should there be an unexpected
downturn in the aerospace industry which could have a significant impact on
TDG’s financial results.
Fitch Rates TDG and TDI as follows:
TDG:
–Long-term IDR ‘B’.
TDI:
–IDR at ‘B’;
–Senior secured revolving credit facility ‘BB/RR1’;
–Senior secured term loan ‘BB/RR1’;
–Senior subordinated notes ‘B-/RR5’.
