Heico (HEI 2.87%) this week delivered solid fourth‐quarter earnings, and guided toward 8%‐10% growth in net sales and net income for 2015. Moreover, management served notice of its intent to "aggressively pursue" acquisition opportunities to generate growth.
Heico's stock is slightly down on the year, even as the commercial aerospace sector has continued to grow strongly. However, given good growth in its commercial aviation end market and its increased cash flow generation, Heico has good growth opportunities going forward. Let's look into the details.
Heico's fourth-quarter earnings
A brief summary of earnings versus analyst expectations:
- Q4 revenue of $292.2 million versus analysts' estimate of $303.8 million
- Q4 earnings per share of $0.48 versus analysts' expectation of $0.46
- Guidance for full‐year 2015 revenue growth of 8%‐10% versus analysts' expectation of 11.4% growth
- Guidance for full‐year 2015 net income growth of 8%‐10% versus analysts' expectation of 10.6% growth
Key takeaways
Heico reports out of two segments. The flight support group is the largest provider of non-OEM, FAA-approved replacement parts in the world, and a provider of aircraft repair and overhaul services. As such, the segment's growth prospects depend upon growth in passenger miles (more aircraft miles mean more servicing needs) and airlines' willingness to use non-OEM replacement parts.
The electronic technologies group manufactures electronic components for use in a range of industries, including aviation, defense, medicine, and telecommunications.
First, a breakout of the key full-year segmental numbers and guidance from the earnings report indicates margins are likely to be flat next year.
| Segment | Revenue (millions) | Operating Income (millions) | Margin | Forecast Revenue Growth | Forecast Earnings Growth |
|---|---|---|---|---|---|
| Flight Support Group | $762.8 | $136.5 | 17.9% | 8%-10% | 8%-10% |
| Electronic Technologies Group | $379.4 | $88.9 | 23.4% | 8% | 8% |
Source: Heico presentations.
The expectation for flat segmental operating margins next year is somewhat disappointing considering that segmental margins have fallen by 50 basis points and 30 basis points for the two segments, respectively, in 2014.
In the earnings release, Eric Mendelson, president of Heico's flight support group, said the group's margin fell both in the quarter and the full fiscal year due to the "impact of decreases in demand for certain products within our specialty products lines as well as increases in certain SG&A expenses to support the higher net sales volumes in our commercial aerospace aftermarket businesses."
Meanwhile, the electronic technologies group margin was hit by "a less favorable product mix, impairment losses and lower than expected operating income from a 2013 acquisition," according to group president Victor Mendelson.
Second, Heico appears to be growing free cash flow more than earnings -- a promising signal that it can leverage revenue growth into free cash flow generation.
| Metric | 2013 | 2014 | Forecast 2015 | Growth from 2013 to 2015 |
|---|---|---|---|---|
| Free Cash Flow (millions) | $113.5 | $174.3 | $175 | 54% |
| EPS | $1.54 | $1.80 | $1.99 | 29% |
Source: Heico presentations.
Third, a potential danger for a company such as Heico is the necessity to hold growing amounts of inventory in order to service aviation customers' needs. However, despite a 12% increase in sales year over year, Heico's inventory was flat from 2013 to 2014. This signals the company can expand sales without having to increase inventory disproportionately.
Fourth, the commentary on acquisitions and debt load (CEO Laurans Mendelson said on the conference call it has no "significant debt maturities until fiscal 2019") indicates investors can expect acquisitions in future.
Where next for Heico?
All told, it was a solid earnings report and outlook statement. The guidance for flat segmental margins is somewhat disappointing, but free cash flow generation continues to grow and inventory is rising slower than sales -- both good signs. Moreover, investors can expect acquisitions to boost revenue growth in 2015.
