Why TransDigm Stock Tumbled 12% Today

By Rich Smith Markets Fool.com


Analyst warns: TransDigm stock could go down in flames. IMAGE SOURCE: GETTY IMAGES.

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What happened

Airplane parts supplier TransDigm Group Incorporated (NYSE: TDG) is seeing its stock pummeled in early Friday trading, down 12% as of 11:30 a.m.

So what

TransDigm is an industrial company that boasts software-company-like profit margins -- an 18.5% net profit margin over the past 12 months, and an operating profit margin of nearly 42%! Numbers like these sound almost too good to be, and according to one analyst, they may not be true for very much longer.

This morning, analysts at noted short-seller Citron Research launched a furious attack on TransDigm stock, calling it"the Valeant (NYSE: VRX) of the Aerospace Industry." As the analyst explains in a write-up on StreetInsider.com today, TransDigm's business model is predicated on its ability to buy up competing airplane parts companies (50 bought so far), fire employees (to cut costs), and raise prices "egregiously" (to boost profits).

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Now what

This sounds like a good way to boost profit margins, and TransDigm's numbers reflect this. But under President Donald Trump, it may also turn out to be a great way to attract the ire of the Twitterer-in-Chief, who has famously promised to cut the cost of defense products -- and TransDigm's single biggest customer is the Department of Defense.

Should Trump take aim at TransDigm, warns Citron, the company's profit margins might be squeezed. In this regard, Citron notes that TransDigm competitor HEICO (NYSE: HEI) earns significantly lower profit margins than does TransDigm. So, what could happen if the new president forces TransDigm to accept prices on its products closer to the norm when bidding on Pentagon projects?

Well, net profit margins at HEICO are only 11.4%, and operating margins are less than 20% -- less than half of what TransDigm is pulling down today. That suggests the risk on this stock could be at least as big as a 50% reduction in profits, and Citron goes so far as to predict an 85% plunge.

If that's the way things play out, TransDigm shareholders are right to be worried.

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Rich Smith has no position in any stocks mentioned, but The Motley Fool owns shares of and recommends both TransDigm Group and Valeant Pharmaceuticals. The Motley Fool also recommends Heico. The Motley Fool has a disclosure policy.