TransDigm Headline Risk Prompts Cowen Cut To Hold

Shares of TransDigm (TDG) continued their slide Wednesday as research firm Cowen cut the aerospace components maker to neutral, arguing that headline risk should limit near-term upside given yesterday's news of a request for an investigation into the company's business practices.

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BACKGROUND: On January 20, Citron issued a short report on TransDigm, writing that "everyone in the aerospace industry knows that one company stands out when it comes to egregious price increases foisted on the government: TransDigm." Following Citron's allegations and the subsequent fall in TransDigm shares, analysts from Credit Suisse, Deutsche Bank and multiple other research firms recommended investors buy the dip, arguing that the short thesis contained no new information and overestimated the company's exposure to government contracts. Roughly a month later, on March 7, news service Capitol Forum published a statement from the Defense Logistics Agency that it takes accusations of rule violations "seriously" and was evaluating whether to take "potential further action" in connection with TransDigm, which spurred Citron to repeat its criticism of the company in a March 9 report.

LAWMAKER REQUESTS TRANSDIGM PROBE: On Tuesday, Representative Ro Khanna issued a request to the Defense Department Inspector General for an "investigation into the business practices" of TransDigm, adding that the company "may be operating as a 'hidden monopolist'" that uses a "range of methods to evade" government contracting regulations.

COWEN DOWNGRADES: Cowen's Gautam Khanna downgraded TransDigm to Market Perform while cutting his price target to $219 from $270, arguing Wednesday that "the outside prospect of a DOD inquiry, potential elimination of the interest deductibility for tax purposes, high financial leverage and headline risks are apt to put a lid on the stock's multiple." The analyst explains that the company enjoyed a strong competitive moat "for years" given a fragmented market and TransDigm's relatively unattractive product niche, but its "profile" has now risen enough for Rep. Khanna to seek the aforementioned probe. While the analyst is "not convinced" that the company's "pricing power will attenuate," he nevertheless doubts that the Defense Department would give TransDigm a quick pass without launching an investigation, "so the stock has more potential to decline - if an inquiry is launched - before it recovers." Khanna notes that TransDigm's recent "notoriety" comes even as Boeing (BA) is "placing greater emphasis" on expanding in aftermarket aerospace, adding that the longstanding investor perception of the company as a defensive pick "may erode."

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Disclosure: None.

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