Author Topic: HEI.A - Heico  (Read 45599 times)

Chalk bag

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Re: HEI.A - Heico
« Reply #20 on: May 27, 2015, 07:40:19 PM »
One thing I can't get my head around is that no body in the OEM industry likes them -- in particular GE, UTX, and Rolls. When you have free-loaders like Heico undercutting you 30-50% on your most profitable products you get pissed, and that's probably why everyone is pushing for the power-by-the-hour model. It sacrifices some margin I bet, but it should cut Heico out completely. Doesn't ramp in full-force until 2022 though I think.
If my math serves me right they are now about 50% reliant on engines and looking to further diversify. I think they mentioned that the deal pipeline is good and I'm comfortable w/ the leverage they can take on. But it's never fun to be the public enemy. Also why can't the Chinese do what they do -- they are notoriously good at copy-cating things at very low prices?

With that said, I probably still want to own just a little bit in case they do a smart transformative deal. Think it's bound to happen within 3 years but tough to underwrite.
« Last Edit: May 27, 2015, 07:54:01 PM by Chalk bag »


fisch777

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Re: HEI.A - Heico
« Reply #21 on: May 28, 2015, 11:26:05 AM »
I met with them a few years ago.  Re the under-cutting issue, Heico is very strategic about how much of the market for a particular aftermarket part it goes for - they believe there is a share % number that allows Heico to push enough volume through to earn nice margins on a given part, but low enough where the OEMs let it happen.  After all, the (non power-by-hour) operator loves/seeks out Heico and is also a customer of OEMs.  It is interesting business, but valuation doesn't look attractive to me.

big_triece

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Re: HEI.A - Heico
« Reply #22 on: September 24, 2015, 01:39:29 PM »
Also why can't the Chinese do what they do -- they are notoriously good at copy-cating things at very low prices?

The primary reason the Chinese haven't made inroads here is because it would be extremely difficult for them to receive PMA approval from the FAA / EASA. Navigating the PMA approval process is much more difficult if the agencies are unfamiliar with the manufacturer. There is months worth of testing / documentation required to get them comfortable with the manufacture of a single part. Plus, at least for the FAA, there is a substantial approval backlog that will take time to get through, and the organization has a preference for companies that they know (e.g., HEI). Even with their ability to copy cat at extremely low prices, it would take years for a Chinese firm to come close to matching HEICO's PMA catalog of over 10,000 parts. Also, as there is such a huge risk of failure associated with these parts, I don't think it's feasible that the airlines would be willing to install cheap Chinese parts in any of their mission critical parts. I don't think they could get to a low enough cost to outweigh the risk to the airline.

marazul

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Re: HEI.A - Heico
« Reply #23 on: October 08, 2015, 07:33:43 AM »
Here is something I wrote recently:


Heico is a high quality business that has provided shareholders with +20% returns for more than 20 years. The Company is controlled and operated by the shareholder-friendly Mendelson family. Currently, Heico trades at ~15.5x forward FCF. This is an attractive valuation for a business with +30% ROIC, ample growth runway and operated by Larry Mendelson, an “Outsider” CEO.

Note: Heico has two shares: HEI & HEI-A. The two are virtually identical in all respects, except for voting. HEI-A carries 1/10th of a vote per share, while HEI carries 1 vote per share. We recommend HEI-A as the company is controlled by the Mendelson family and HEI-A trades at a 12% discount.

Heico has two business segments. 1) The flight support group (60% of EBIT) is the largest provider of non-OEM FAA-approved aircraft replacement parts. They manufacture and distribute aftermarket replacement parts that are +25% cheaper than those provided by the OEMs. The airlines have basically two options once they need to replace a part of a plane, pay a premium by buying from the OEM or buy the Heico FAA-approved part at a significant discount. Heico offers over 9,000 products across the plane. 2) The electronic technologies group (40% of EBIT) is a provider of mission-critical niche products used in the medical, space, telecom and defense industries. Products include calibration equipment, microwave amplifiers, fuel level sensing systems and underwater beacons.

The Mendelson family has built the company through small acquisitions (more than 50) since they took control in 1990. The industry structure is characterized by small operators that only offer a couple of products, in many cases just one part of a plane. Heico has historically acquired these operations and added these products to their distribution network. I expect them to continue rolling up the industry, as they have said in many of their calls. According to management, they have less than 2% share of the replacement parts market so the opportunity is large. There are significant benefits of scale in this business and this might point towards more consolidation. For example, there are significant upfront R&D expenses to design new parts, the FAA approval process requires resources and customers prefer a large supplier that offers various parts. There are also barriers to entry as the airlines take many years to trust new suppliers and Heico has built a trustworthy brand over the years. They have also built expertise regarding the FAA approval process. These barriers to entry and the mission critical characteristic of the products, make this a great business.

Currently, the Company is under levered at ~1.0x net debt/EBITDA and this gives management the ability to make a big opportunistic acquisition. The CEO has said in the past that he is comfortable with less than 4.0x leverage. We expect Heico to continue following their strategy and be the consolidator in this fragmented space. Management has been able to generate very high IRRs on their acquisitions, so investors should be happy if they continue to invest the free cash flow in a tax-efficient way.

A comparable company with a similar strategy, is the highly successful Transdigm. This comparable has embarked in the same strategy of acquiring small operations using high levels of leverage. Transdigm might be considered a higher quality company given that it is the sole provider of approximately 75% of its products. This is reflected in its EBITDA margins of more than 45% compared to Heico´s 22.7%. Besides that, the two companies operate mainly in the aftermarket aerospace business and share a similar business strategy. Transdigm trades at a rich 22.1x forward FCF and 15.3x EV/EBITDA, compared to Heico 15.5x and 12.0x, respectively. Transdigm also employs significant leverage with net debt/EBITDA of 6.0x compared to 1.0x for Heico. So comparing the two, Heico looks more attractive. In addition, Heico is 6 times smaller than Transdigm in terms of enterprise value.

So why invest in Heico now? I believe this is an opportunistic moment to enter the stock for several reasons. The stock hasn´t moved in more than a year and is down 15% from its high. There is fear of power by the hour or basically that OEMs (e.g. Rolls Royce or GE) secure the maintenance over the life of the product they sell. This would block the PMA part providers (Heico) from being able to sell their products to the airlines. There are several mitigants to this issue. For example, Heico provides PMA parts for several sections of the plane, not just the engine. Also, the airline wants to have more than one provider of parts for each section of the plane in order to have some pricing leverage. Lastly, Heico offers the best value proposition and we believe over-time the players of the industry will realize this. Second reason the stock has languished is because the market thinks the aircraft cycle is reaching its end. Certain investors believe that the backlogs and new orders will likely be cancelled as soon as airlines face difficulties. Heico will be less affected than its peers because most of its products are aftermarket replacement parts and the demand driver is not new planes being built. They would even benefit from retrofits.

So what should investors expect and why is this a great opportunity? I think Heico should trade closer to 18.0x forward FCF or 15% above current price. In addition, I believe investors should expect mid-teens operating earnings growth per year for the foreseeable future (management has argued thay can grow earnings at 20% for the next 3-5 years). The business should grow organically at more than 6%. Why? Revenue passenger miles have grown and should continue to grow in the following years at ~5.5%. In addition to that, PMA parts might/should take share from OEMs as airlines and lessors get comfortable with this option. In addition, Heico might use some pricing power. Besides organic growth, we expect further acquisitions. If the company uses most of the free cash flow in acquisitions and maintain their historic discipline, then we could expect that to add another ~7% to operating earnings. That gets us to 6% organic growth plus 7% growth form acquisitions, or 13% without using the balance sheet capacity. As mentioned before, Heico is underlevered and has debt capacity to fund future investments. Let´s assume they take leverage to a comfortable 3.5x. Using current comps for transactions in the space, they could increase debt by approximately $1,000 million (taking into account PF EBITDA) and that might add more than $0.70 in FCF/share.

On the upside, let´s assume the stock rerates to 18.0x forward FCF and that the company takes leverage to 3.5x. Pro forma, we can expect forward FCF/share of $3.50. At 18.0x, that takes the stock to $63.00 or 41.7% above current price. Besides that one-time upside option, you are buying a long-term mid-teen compounder at an attractive price.

I will leave you with some quotes from Larry Mendelson:

"We have – as you know, we have the firepower to buy much, much larger companies. I mean, we have this $800 million revolver unsecured. The banks want to bring it to $1 billion. At the moment, we can accomplish our growth objectives without going to $1 billion. But in addition to that, we have really – I don't want to say unlimited, but unlimited in terms of how much we need to meet growth objective. We targeted 20% growth over the next three to five years bottom line, and we easily have the financial capability to do that without stretching and without putting the company's neck on the line. But it's really we are opportunistic buyers and we buy good properties at good prices. They're accretive and they cash flow. And that's really our formula."

"As we have said before, our mission is not to grow sales to make a larger Company, but to generate income and strong cash flow for our shareholders."

"Somebody once told me that earnings per share is opinion and cash flow is fact, and Heico operates on that theory."

"I can go out and buy things that have big CapEx and working capital requirements and then go to the bank, or go to the investment bankers and raise equity to pay for. Anybody can do that and some companies do to raise the top line and show, oh, we're growing the top line. We don't do that. We want to – since we're the larger shareholders, it's our money at stake and every investor in HEICO is our partner.
So if we guess right and we make our money work for us, we're making our money work for every single investor. That's our philosophy. That's the basic philosophy. And if we see a great company and it's 20% or 25% return on investment, hey, we're going to buy that company because that's a wonderful return. And if it doesn't grow that much, okay, it doesn't grow that much. But that's a wonderful return and we take that money and put it towards acquisitions of faster growing ones."

"When airlines start they have leverage with manufacturers, they take a lot of delivery and that is honeymoon phase because equipment works well. And then as time goes on the reliability will go down and cost will go up and the will start getting cost wise with some of OEMs and that´s when Heico comes in."

giofranchi

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Re: HEI.A - Heico
« Reply #24 on: October 08, 2015, 08:14:41 AM »
Thank you marazul!
Let me ask you, if I may: do you also hold an investment in TDG, or have decided to concentrate only in HEI.A?

Cheers,

Gio
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marazul

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Re: HEI.A - Heico
« Reply #25 on: October 08, 2015, 08:20:39 AM »
No position in TDG. Scared by the leverage and valuation. Have been wrong on the name for a while, they continue performing.

giofranchi

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Re: HEI.A - Heico
« Reply #26 on: October 08, 2015, 08:35:01 AM »
No position in TDG. Scared by the leverage and valuation. Have been wrong on the name for a while, they continue performing.

It seems to me Mr. Howley is very focused on how to use TDG’s balance sheet the best way possible… Though lots of leverage is cause for concern most of the time, I think TDG might be the exception.

Of course, it is not cheap, but it has still lots of room to grow, and even with a significant contraction in the multiple it is selling for TDG might still turn out to be a good investment.

This being said, I’ll now consider an investment in Heico!

Thank you,

Gio
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big_triece

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Re: HEI.A - Heico
« Reply #27 on: October 08, 2015, 12:40:51 PM »
Thanks for sharing the write up on HEI, Marazul. I've been looking into the company for ~5-6 months now and agree with everything you wrote. I wanted to get your thoughts on one question surrounding the business that I have not been able to understand yet. Do you know if there are a certain number of the PMA parts that account for the bulk of the revenues / earnings? My concern is that even though they advertise having 10k+ PMA parts, they could only really be selling 20% of those. Even worse is my concern that the 20% could all be specifically for a Rolls-Royce engine (and at risk due to the power-by-the-hour contracts). In your research, have you been able to get any insight into the makeup / concentration within the PMA business?

Thanks!

marazul

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Re: HEI.A - Heico
« Reply #28 on: October 08, 2015, 02:33:05 PM »
I don´t have a good answer. They have been diversifying away from power by the hour making small acquisitions throughout different sections of the plane. As you said, they have thousands of parts that cover various sections of the plane, not just the engine. In addition, approximately 40% of operating profit comes from the electronics group (not flight support). So my guess is that the total exposure to Rolls Royce or GE should be relatively low. I also think this management team is on top of any trend that threatens their model and they have been making adjustments.

giofranchi

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Re: HEI.A - Heico
« Reply #29 on: November 03, 2015, 07:05:15 AM »
I have sold some TDG today and used the proceeds + some new cash to open a position in HEI-A.
Is HEI-A of lower quality than TDG? Maybe.
Is its price more attractive? I think so.
Is its debt load lighter? For sure.
Overall, I think a good way to diversify.

Cheers,

Gio
Portfolio: AAPL, AMZN, BABA, BOSS, BRK.B, FB, FFH, FIH.U, FINX, FWONA, GOOG, IBB, JPM, LBRDA, MKL, NKE, QQQ, SFTBF, SMH, TCEHY, V, XBI, XT