Heico Corp. (HEI)(HEI.A) is the world's largest independent (non-OEM) provider of Federal Aviation Administration (FAA)-approved replacement parts for commercial and military aircraft (part of Heico's Flight Safety Group). The company also designs, manufactures and sells electronic, microwave and electro-optical products in its Electronic Technologies Group.
While the company was founded in 1957 to design laboratory equipment, its focus started to change in 1985 when a faulty part on a Boeing 737 caused an engine fire and led to the death of 55 people. Regulators pushed for the part in question to be changed at regular intervals, but supplier Pratt & Whitney couldn't keep up with the sudden surge in demand. As a result, Heico was authorized to produce a generic replacement under a FAA program called Parts Manufacturer Approval (PMA).
A few years later, current management (the Mendelson family) bought a meaningful stake in the company and assumed control of operations. (Today, management, the board of directors and employees collectively own more than 20% of Heico.) Chairman and CEO Laurans Mendelson reasoned that if Heico could secure a PMA for a critical part, it could probably do the same for other replacement parts. The bet paid off: Today, the company has FAA approval on more than 11,000 parts and is producing 300 to 500 new parts a year.
The benefit Heico provides to airlines is significant cost savings: Barron's estimates that the average saving on PMA or non-OEM replacement parts is 30-50% (OEM suppliers make very little money on new builds, with profitability largely from aftermarket parts). For customers, the value proposition is an "exact reproduction" of OEM parts at much lower prices (Heico estimates that it collectively saves the top 20 airlines roughly half a billion dollars a year). The result has been decades of strong double-digit growth, with a nearly 70-fold increase in revenues since 1990.
That has translated to fantastic results for shareholders: Since current management took control, the stock has generated a compounded return of roughly 25% per year; an investment of $100,000 back in 1990 would be worth roughly $55 million today.
Over time, revenues have been driven by a combination of organic growth and acquisitions (in total, it has completed 75 acquisitions since 1990). As noted in the Barron's write-up:
"Every year, engineers leave Boeing, UTX, and other large aerospace companies to start their own businesses but lack the national scale and FAA trust to be anything more than marginal players. Heico has bought dozens of small companies, leaving 20% of the equity with the original owners. It feeds their production into its national distribution system and FAA approval process."
Despite nearly 30 years of growth under the current management team, the company estimates that it supplies a low-single digit share of the market for jet engine and aircraft component replacement parts. Much like with Hexcel (HXL), which I looked at a few weeks ago, Heico is benefiting from structural tailwinds (global passenger traffic is expected to increase at a mid-single digit CAGR over the next 20 years). That should provide support for revenue growth for years and decades to come.
Heico appears to be a good business with a solid management team. It has reported significant growth and generated outsized returns while diversifying its business (engine parts accounted for roughly 90% of Heico's replacement parts 15 to 20 years ago, compared to less than 50% today). In addition, the results have been on fire as of late. As Laurans noted on the second quarter conference call, "In the 29 years we [the Mendleson's] have been running HEICO, I have never seen a business climate as positive and strong as this one."
But Mr. Market hasn't missed this. Based on Bloomberg estimates, the stock trades at roughly 45x forward earnings. The multiple has roughly doubled since 2015. Clearly investors are assuming that the company's record of double-digit growth will be sustained for many years to come.
By my math, even with some pretty impressive results over the coming years, it may earn about $4.50 per share in a few years (fiscal 2023). For what it is worth, that's roughly in-line with management's expectation of 15-20% profit growth. Relative to a current stock price of $110 for the class-A shares, that's still a multiple of roughly 25 times on 2023 earnings (I don't see any reason why an investor would pay up for the voting shares in this situation).
Here's another way to think about it. During Heico's second quarter conference call, Laurans discussed its mergers and acquisitions discipline, saying, "We're looking at a lot of different deals, [but] some of them are out of our price scope ... again, we don't pay 12 or 14 times [EBITDA]." By comparison, HEICO currently trades at more than 30 times EBITDA. While that isn't an apples-to-apples comparison, it does give a sense of how much the valuation has run in the past few years.
In summary, I'd love to invest in this business -- but not at the current price.
For now, I'll wait patiently and hope for a chance to do so at a later date.
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This article first appeared on GuruFocus.
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