Following TransDigm Group Inc.'s (TDG) recently announced plans to issue
up to $3.2 billion of debt, Fitch Ratings anticipates a possible
negative rating action on TDG subsidiary TransDigm Inc.'s (TDI) senior
subordinated debt. The new debt will be used to refinance $1.6 billion
of senior subordinated notes due in 2018 and to fund a cash dividend in
the range of $900 million to $1.5 billion.
Fitch expects the issuance to be neutral to TDG's and TDI's long-term
Issuer Default Ratings (IDRs) and the ratings of TDI's senior secured
facilities. However, the up to $1.6 billion incremental debt may have a
negative impact on TDI's senior subordinated debt ratings depending on
the size of issuances and the updated capital structure of the company.
The possible negative rating action would be limited to one notch.
The Rating Outlook is Negative. While Fitch expects TDG's projected
metrics will still be consistent with the current 'B' IDR, the level of
support for this rating will be reduced by the new debt. Approximately
$5.7 billion of outstanding debt is covered by Fitch's ratings. A
complete list of current ratings follows at the end of this release.
KEY RATING DRIVERS
Fitch's ratings for TDG reflect 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 that 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. TDG also has no
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; 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.
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 free cash flow (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. Fitch calculates the
expected recovery for bank-debt holders after giving effect to the
anticipated debt issuances will remain 'RR1', indicating recovery of
91%-100%. While the expected recovery of senior subordinated notes are
currently 'RR5' (recovery in the range of 11%-30%), Fitch calculates the
recovery prospects for this class of securities may decline to 'RR6'
(recovery in the range of 0% - 10%) following the anticipated issuance
of the incremental indebtedness the majority of which is expected to be
comprised of senior secured facilities.
The Negative Outlook is supported by significant leverage of the company
and its diminished ability to de-lever rapidly. This correspondingly
impacts TDG's financial flexibility to pursue large-scale debt-funded
acquisitions at the current ratings.
Fitch estimates TDG's leverage could increase to up to 7.4x following
the completion of the debt offering, up from approximately 6.0x as of
March 29, 2014. The increased leverage is in line with the company's
historical leverage which typically fluctuates between approximately
4.5x and 6.0x, occasionally reaching higher than 7.0x. At the end of
fiscal year ended Sept. 30, 2013, TDG's leverage was approximately 6.6x,
up from 4.6x at the end of fiscal 2012. TDG's leverage is somewhat high
for the rating; however, it is mitigated by strong margins and positive
FCF generation.
At March 29, 2014, TDG's liquidity consisted of $476 million in cash and
$303 million of availability under its revolver ($310 million less $7.3
million in letters of credit), partially offset by $23 million in
current amortization payments under the term loan. TDG has no major
maturities until 2017. Fitch expects TDG to maintain a solid liquidity
position in fiscal 2014.
In fiscal 2013, TDG generated approximately $1.6 billion negative FCF
driven by special dividends of approximately $ $2 billion. Excluding
special dividends, TDG generates solid positive FCF, aided by typically
low capital spending and high margins. Capital expenditures tend to be
less than 2% of sales per year. Excluding special dividends, Fitch
expects TDG to generate approximately $370 million of FCF in fiscal
2014. Projected future cash flows should be sufficient to fund
day-to-day operations while allowing the company the flexibility to
pursue modest acquisitions.
TDG is exposed to three business sectors: commercial airplane original
equipment (OE), and commercial aftermarket and defense (both original
equipment and aftermarket). TDG's sales growth rates during the latest
economic downturn were primarily driven by the acquisitions and the
stability of defense spending which significantly moderated
year-over-year organic sales declines in commercial OE and aftermarket
sales. Fitch considers the conditions within the industry to be
supportive of the rating.
Rating Sensitivities:
A negative rating action may be considered should the weakening of
global economy or a downturn in Aerospace sector have a more significant
impact on the company's earnings, margins and FCF than currently
anticipated. A positive rating action is not likely in the intermediate
term, but Fitch may consider a positive rating action if the company
maintains its leverage level within the range of 4.5x to 5.6x along with
its strong revenue growth and high cash generation.
Fitch currently rates TransDigm Group Inc.'s (NYSE: TDG) and its
indirect subsidiary TDI as follows:
TDG
--Long-term IDR 'B'.
TDI
--IDR 'B';
--Senior secured revolving credit facility 'BB/RR1';
--Senior secured term loan 'BB/RR1';
--Senior subordinated notes 'B-/RR5'.
The Rating Outlook is Negative.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent
and Subsidiary Linkage' (Aug. 5, 2013).
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=715139
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