TGI - Triumph Group: Concerns On Pension And Refinancing

Summary

• TGI has upcoming debt maturities and pension contributions as pressing issues.
• Management guided to positive FCF expected in FY23.
• It would be wiser to stay neutral or take a small position and wait for refinancing activities to clear before sizing up.

Summary

As a whole, I don't see any major changes to the strength of the equity story for Triumph Group ( TGI ) as a result of 3Q23 earnings. There hasn't been much of a shift in the long-term story, with FCF continuing to serve as key metric. However, TGI's upcoming debt maturities and pension contributions are the most pressing issues. The current rates environment needs to improve so that management can take advantage of refinancing opportunities; otherwise, there may be short-term headwinds at the bottom line. Therefore, while I am optimistic about the long-term growth story, it is prudent to stay neutral or hold only a small position today until the fog of uncertainty (refinancing) lifts.

Earnings overview

Nearly 30% of Systems & Support revenue in 3Q23 came from commercial MRO, up 59% year-over-year. Notably, the $83 million in revenue represents a sustainable increase from the $60 million and $63 million in Q1 and Q2 respectively. In addition, as travel is on the upswing, which, combined with a shortage of new planes, is driving up aftermarket demand. Suppose imply 20%+ growth in commercial MRO in FY23. Also, commercial OEM sales were up 18% on higher production rates, which is in line with growth trends seen in the first half of the year thanks to a one-time sale of IP.

The Interiors division of Structures saw minor profitability. The Aerospace Structures segment generated $44 million in revenues, with an adj EBITDA margin of 13%. This figure included $7 million in non-recurring revenues and $4 million in profits. However, in the next few quarters, this one-time revenue will begin to taper off. In my opinion, the increased production of 787s and the narrowbody ramp will drive both revenue and profit.

Backlog

The total backlog for TGI dropped by 18% y/y to $1.59 billion, but 3Q23 saw a 21% increase in bookings, to $400 million, for a book-to-bill ratio of 1.21x. About 45 percent of wins in this quarter (~$130 million) were tied to either new products or customers. Relatively to consensus, the estimated $1.03 billion backlog that will be shipped within the next 12 months represents a sizable portion of consensus estimate (which means it is unlikely to miss). TGI, in my opinion, will be able to support its expansion by broadening its exposure to new platforms and customers. One primary method of accomplishing this goal is by persistently seeking out opportunities to perform OE and MRO on military platforms. Recent successes are promising because they show no sign of slowing.

Systems and Support

Revenue grew by 21% on an organic basis in 3Q23 as narrowbody volumes with the Military stabilized. Specifically, there was a rise of 19% in sales of Commercial OE and a rise of 59% in sales of MRO. The uptick in international flight hours was the primary factor in MRO expansion. The military saw a decline in volumes of 1% year over year, but a rise of 5% quarter over quarter. Overall, I expect this segment to continue growing strongly as the commercial aero business continues to improve, and management has previously laid out a framework for 18-22% growth in FY23.

In terms of profitability, adj EBITDA margins rose to 17.5%, a slight increase of 20bps. Profitability varied by quarter due to fluctuations in the sale of military spares, but management is confident that rising narrowbody volumes will eventually boost the bottom line. Management's long-term goal is to achieve low-to-mid 20% margins in Systems and Support by the year 2025. As TGI continues its transition to narrowbody aircraft, I am confident that they will be able to achieve this goal, which will aid in the gradual increase of EBITDA.

FCF

TGT has announced that they expect higher FCF in FY23, with a midpoint of -$60m. This translates to an implied $65 million FCF in 4Q23 (FY23 guidance - 9M23 FCF), which is mainly driven by working capital and inventory management. I expect TGI's FCF to remain in positive territory going forward as the company maintains positive EBITDA growth based on its long-term framework and improves its working capital management.

CY24 refinancing

My calculations suggest that TGI will need to refinance their $1.1 billion in debt because they will not have enough cash on hand to make the required repayments. Currently, TGI's 2024 maturities trade at around a 6% to 7% yield. and its senior Notes maturing in 2025 are currently trading at a yield of 11.56 percent. TGI needs to start working on a refinance deal now because, if current interest rate trends continue until the end of CY23, rates could be significantly higher than they are right now. Consequently, I am concerned about the amount by which interest costs would increase after the refinancing.

Pension contribution

TGI pension contribution, in my opinion, is something to monitor. Even though management didn't plan on making pension contributions last year, I believe there is a growing need to do so in light of the current environment of rising interest rates. TGI's gross obligation decreases accordingly every time the discount rate rises. Unless there is a turnaround in rates before the firm revalues its holdings, this could necessitate additional financing.

Conclusion

TGI 3Q23 earnings showed steady growth in the commercial MRO and OEM sales, while the Interiors division of Structures saw minor profitability. And more importantly, management guided to positive FCF for FY23, implying $65 million FCF in 4Q23. That said, TGI's most pressing concerns are its upcoming debt maturities and pension contributions. There could be short-term headwinds to the bottom line unless the current rates environment improves. I believe there is long-term growth potential, but until the current cloud of uncertainty lifts, it is prudent to hold only a small position.

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