News Column

Fitch: Transdigm's Proposed Debt Actions Could Pressure Subordinated Ratings

May 15, 2014

NEW YORK--(BUSINESS WIRE)-- 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

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

David Petu, CFA

Director

+1-212-908-0280

David.petu@fitchratings.com

Fitch Ratings, Inc.

33 Whitehall Street

New York, NY 10004

or

Secondary Analyst

Craig Fraser

Managing Director

+1-212-908-0310

Craig.fraser@fitchratings.com

or

Committee Chairperson

Sharon Bonelli

Managing Director

+1-212-908-0581

or

Media Relations

Brian Bertsch, +1 212-908-0549

brian.bertsch@fitchratings.com

Source: Fitch Ratings


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