Can This Aerospace Stock Provide Higher Returns Than Textron?

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The shares of Textron (NYSE: TXT) observed a strong rally in 2021 largely due to a surge in the company’s Aviation segment’s order backlog. The company designs and manufactures civilian and military helicopters and business jets. Considering the uptick, Trefis believes that TXT stock has reached its near-term potential. Is there a better alternative to Textron in the Aerospace industry? TransDigm (NYSE: TDG) develops highly engineered aircraft components for commercial and military aircraft. TDG stock has recovered to pre-pandemic levels and we believe there is room for more. Interestingly, TransDigm and Textron have a comparable balance sheet size despite a sharp contrast in revenues and earnings. Our interactive dashboard, Textron vs. TransDigm Group: Sector Peers, But Transdigm Group Is A Better Bet, highlights a slew of factors such as historical revenue growth, returns, and valuation multiples.

1. Revenue Growth

TransDigm’s growth was much stronger than Textron’s before the pandemic, with its revenues expanding at an average rate of 18% per year from $3.1 billion in 2016 to $5.2 billion in 2019 assisted by a series of acquisitions. Textron’s revenues have remained relatively flat at $14 billion in the past few years largely due to a slowdown in the commercial aviation industry. TransDigm observed a top-line contraction of just 2% compared to a larger 15% by Textron in 2020.

  • TransDigm’s three operating segments, Power & Control, Airframe, and Non-Aviation contribute 52%, 45%, and 3% of total revenues, respectively. Power & Control and Airframe segments have observed strong growth in recent years largely driven by pent-up demand by its defense customers. The Power & Control segment develops components such as actuators, pumps, valves, sensors, etc., which provide power to electrical, hydraulic, and mechanical motion control systems. Broadly, the company’s product offerings are for the aerospace industry.
  • TransDigm provides its products and services to Commercial OEM, Commercial Aftermarket, and Defense sectors. In the last five years, the share of the defense sector has ranged from 30-42% of total revenues.
  • Textron’s four operating segments, Aviation, Bell, Systems, and Industrial contribute 38%, 24%, 10%, and 28% of the total revenues, respectively. The company’s Aviation segment observed production hiccups and order cancellations due to tepid travel demand and a fall in discretionary spending during the pandemic. In recent quarters, the Aviation segment has reported a 112% surge in order backlog from $1.6 billion in Q4 2020 to $3.4 billion in Q3 2021. However, the total order backlog has only observed a 3% growth over the same period. (related: Will Textron Stock Continue To Trend Lower?)
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2. Returns (Profits)

TransDigm has consistently reported a significantly higher net margin compared to Textron – leading to better earnings and cash flow generation.

  • In 2020, Textron’s Aviation, Bell, Systems, and Industrial segment reported an operating margin of 8%, 13%, 11%, and 6%, respectively. While the Bell segment sustained earnings during the crisis, the growing private jet demand is expected to boost the Aviation segment’s profits in the coming years.
  • Similarly, TransDigm’s Power & Control, Airframe, and Non-Aviation segments reported an operating margin of 46%, 35%, and 1%, respectively. Consistent with top-line expansion, the company’s Power & Control and Airframe segments are key earnings drivers.
  • While Textron has been consistently returning capital to shareholders as dividends and share buybacks, TransDigm has no official plan for the near-term (apart from the special declaration in 2019) due to sizable long-term debt obligations.
  • TransDigm’s long-term debt obligations have more than doubled from $10 billion in 2016 to $20 billion in 2020 assisting the in-organic growth strategy.
  • Interestingly, TransDigm and Textron have a comparable balance sheet with $18 billion and $15.5 billion of total assets, respectively.

3. Risk

Per recent filings, TransDigm and Textron reported $19 billion and $3 billion of long-term debt, respectively. Given a comparable balance sheet size, TransDigm stock is a risky pick from the perspective of financial leverage.

  • Higher financial leverage coupled with continued revenue growth is responsible for generating surplus equity returns. Hence, TransDigm has been consistently utilizing operating cash to invest in its business and acquire new companies to further its growth strategy.
  • However, Textron’s stable top line and thin margins are weighing on earnings and shareholder returns.
  • In 2020, TransDigm incurred $1 billion of annual interest expenses and still earned $699 million of net income on $5 billion of net sales. Whereas Textron incurred $161 million in interest costs and earned just $309 million of net income on $11.6 billion of total revenues.
  • Given strong growth prospects despite a highly levered balance sheet, TransDigm stock is likely to provide better returns to investors. (related: Air Travel Demand To Push Boeing Stock Higher?)

What if you’re looking for a more balanced portfolio instead? Here’s a high-quality portfolio that’s beaten the market consistently since the end of 2016.

Returns Jan 2022
MTD [1]
2022
YTD [1]
2017-22
Total [2]
TXT Return -1% -1% 57%
TDG Return 2% 2% 160%
S&P 500 Return -1% -1% 110%
Trefis MS Portfolio Return -5% -5% 273%

[1] Month-to-date and year-to-date as of 1/6/2022
[2] Cumulative total returns since the end of 2016

 

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