A Look At The Intrinsic Value Of TransDigm Group Incorporated (NYSE:TDG)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, TransDigm Group fair value estimate is US$1,338

• Current share price of US$1,339 suggests TransDigm Group is potentially trading close to its fair value

• Our fair value estimate is 6.5% lower than TransDigm Group's analyst price target of US$1,431

Does the June share price for TransDigm Group Incorporated (NYSE:TDG) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for TransDigm Group

The Calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$1.95b	US$2.33b	US$2.72b	US$3.13b	US$3.40b	US$3.61b	US$3.79b	US$3.95b	US$4.10b	US$4.23b
Growth Rate Estimate Source	Analyst x10	Analyst x11	Analyst x7	Analyst x2	Analyst x1	Est @ 6.12%	Est @ 4.99%	Est @ 4.21%	Est @ 3.66%	Est @ 3.28%
Present Value ($, Millions) Discounted @ 6.7%	US$1.8k	US$2.0k	US$2.2k	US$2.4k	US$2.5k	US$2.4k	US$2.4k	US$2.3k	US$2.3k	US$2.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$23b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 6.7%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$4.2b× (1 + 2.4%) ÷ (6.7%– 2.4%) = US$100b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$100b÷ ( 1 + 6.7%)¹⁰= US$52b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$75b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$1.3k, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at TransDigm Group as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 6.7%, which is based on a levered beta of 0.942. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for TransDigm Group

Strength

• Earnings growth over the past year exceeded the industry.

Weakness

• Interest payments on debt are not well covered.

• Dividend is low compared to the top 25% of dividend payers in the Aerospace & Defense market.

• Expensive based on P/E ratio and estimated fair value.

Opportunity

• Annual earnings are forecast to grow for the next 3 years.

Threat

• Debt is not well covered by operating cash flow.

• Total liabilities exceed total assets, which raises the risk of financial distress.

• Annual earnings are forecast to grow slower than the American market.

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For TransDigm Group, we've compiled three additional items you should consider:

1. Risks: For instance, we've identified 3 warning signs for TransDigm Group (2 are concerning) you should be aware of.

2. Future Earnings: How does TDG's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com