HEICO: Flying Too High (NYSE:HEI)

HEICO Corporation (NYSE:HEI) (“Heico”) is a diversified aerospace, aviation, defense and electronics company which focuses on niche markets and has seen much coverage on this platform, I must say.

In the meantime, the company has quite a stellar track record. Founded in the 1950s, the company has seen solid growth and delivered on >20% annual returns since the early 90s, with a very much incentivized management team leading the business as they hold about a fifth of the shares.

The Business

HEICO is all about the customer, as the company has grown from just a $20 million business in the early 1990s to a $2 billion business at the start of the pandemic. The company has been substantially and consistently profitable and is basically organized under two segments which are roughly equal in terms of size: being the flight support group and electronic technologies group, of which the latter is far more profitable.

Commercial aviation is the biggest market with a near 40% revenue contribution, as defense markets are almost equally large, complemented by space and other markets which are much smaller. The company is quite diversified in terms of components, client names and customer groups, which makes it a bit of a macro play on the fortune of these industries, yet the company has seen a consistent outperformer.

Just a $1 share in the 1990s, a $10 share in 2008, a $30 share in 2016, shares broke the $100 mark in 2019. Ever since, shares have been trading between $100 and $150, that is since the start of the pandemic, as shares have rallied above the higher end of the range now, trading near the all-time highs at $155 here.

Current Performance

In December 2021, the company posted its fiscal 2021 results. Full year sales improved modestly from $1.79 billion in 2020 to $1.87 billion as operating earnings improved roughly by similar percentages to $393 million, translating into very compelling margins. After taxes, non-controlling interests and minimal interest costs, a net profit of $304 million translated into earnings of $2.21 per share. Net debt of $128 million was minimal with EBITDA coming in around half a billion, yet the earnings power revealed sky-high expectations. After all, this was a near $150 stock, and with earnings power just over $2 per share, the resulting 70 times earnings multiple certainly was quite steep.

Given the strong financial footing, HEICO has been active to further increase its lineup of offerings. In February, the company acquired a majority stake in Pioneer Industries, LLC, and with no financial details have been announced, the deal looks relatively small.

In February, the company posted a 17% increase in first quarter sales, with the bottom line performance actually surpassing topline sales growth a bit. A month later, the company announced the next bolt-on deal with the purchase of Flight Microwave, with again no financial details being announced. In May, second quarter sales rose 15%, with earnings growth again coming at more impressive percentages.

With the company not feeling comfortable to provide a 2022 guidance, it is clear that the company is generating over $2.0 billion in sales here as earnings trend close to $350 million, or $2.50 per share here. Despite some bolt-on dealmaking, net debt just shy of $150 million remains minimal, barely equal to a quarter of trailing EBITDA here.

The Premium

It is hard to justify the premium of HEICO, if you ask me. A share count of 138 million shares translates into a $21.5 billion equity valuation at $155 per share, equal to more than 10 times sales and still about 60 times realistic earnings. These are very high multiples, certainly for a steady and well-performing business, certainly, as operating margins of 20% leave little room for realistic margin expansion here.

In the summer, the company has gotten a bit more active to use its balance sheet strength. By mid-July, HEICO acquired a 96% stake in Accurate Metal Machining, and while no financial details were announced, this was a larger deal given that Accurate employs some 250 workers.

Towards the end of the month, HEICO reached a deal to buy French-based Exxelia International in an EUR 467 million deal. The deal is the largest in HEICO’s history and adds more than 2,000 team members as well as some EUR 190 million in revenues, as the deal was well-timed following recent dollar strength. The resulting 2.5 times sales multiple is far lower than HEICO at large, which is beneficial even if margins are lagging a bit, but these have not been quantified. Nonetheless, net debt of roughly $600 million on a pro forma basis only translates into a 1 times leverage ratio, as the deal will boost sales by about 10%.

Hence, there are reasons to be upbeat on the business, but even another year of 15-20% earnings growth only translates into a 50 times earnings multiple, which can hardly be called appealing.

While I greatly admire the business and its long-term track record, valuations simply are too lofty to be even tempted to get involved here.