Heico (NYSE:HEI), like Boeing (NYSE:BA), is reliant on the commercial aerospace sector for a significant share of its revenue. And it, too, has felt the impact of the COVID-19 pandemic, which has compelled airlines to retrench and dial back purchasing, which seems certain to cause a multiyear slump in aerospace sales.
But the two companies' stock performances have diverged so far in 2020: After losing more than half its value in the February-March market plunge, Heico is back to being down just 8% year to date, while Boeing is still down 54%.
In its quarterly earnings release on May 26, Heico showed why it has held up better than most of its commercial aerospace brethren and made its case for why it remains one of the sector's top buys. Here's how Heico is managing through the COVID-19 crisis, and what to expect from it in the months to come.
A strong quarter flying into the pandemic
Heico booked quarterly earnings of $0.55 per share on revenue of $468.1 million, beating Wall Street expectations for $0.44 per share in earnings on $462.86 million in revenue.
The company's advantage over most of its peers in this environment is its substantial non-aerospace business. Among other things, it supplies components for in-demand medical devices such as ventilators. Overall revenue fell 9% year over year in the quarter, weighed down by an 18% drop in the company's aerospace unit that was partially offset by a slight sales gain from its electronic tech group.
During a post-earnings call with analysts, CEO Laurans A. Mendelson emphasized the revenue diversity. About half of net sales are derived from defense, space, and other industrial markets, he said, and "demand for products in that half of our business has not been fundamentally impacted and its operational results remain materially consistent with the financial expectations prior to the outbreak."
The company said that aerospace sales were solid in February and into March, but began to slide in April. It's worth noting that the fiscal quarter in question only ran through April 30. The impact of the pandemic is likely to be more pronounced in the current quarter.
Heico ships most of its production within 30 days of when the orders come in, so the company has little visibility into the future. Management says it can handle a 50% to 60% drop in sales from its flight support unit and still break even, but investors should hope the company isn't forced to prove it for a sustained amount of time.
There's still a lot of risk to its portfolio, including the potential for supply chain disruptions or a fall in demand for other products if the pandemic throws the economy into a prolonged recession. But relative to other aerospace suppliers that generate most of their earnings from that sector, Heico has held up well so far in the pandemic and should be able to rebound ahead of a full aviation recovery.
Heico remains opportunistic
Despite the diversity of its revenue sources, Heico will need airlines to rebound before its shares can really take flight again. However, the company gets a significant portion of its aerospace revenue from aftermarket (spare part) sales, and it seems likely that as airlines begin flying more of their planes again, they'll be relying on existing equipment rather than stretching their balance sheets to buy new planes.
Therefore, Heico is among a handful of companies likely to rebound before new plane manufacturers like Boeing.
Mendelson said on the conference call that Heico's mix of products, which include a number of tools that help make planes more efficient, will be of particular interest to airlines as they restore service.
Once commercial air travel resumes, cost savings will most likely be a priority for our commercial aviation customers and we do anticipate recovery in demand for our commercial aviation products, which frequently provide aircraft operators with significant cost savings. Furthermore, we believe that our cost-saving solutions and robust product development programs will enable us to potentially increase market share and emerge with a stronger presence within this market.
There is a risk that some of the now-grounded aircraft will be scrapped for parts and components, which could sap sales from Heico and other vendors. But aerospace companies have been saying as a general rule that this strategy is only cost-effective for parts that cost about $5,000 or more, and those only account for about 10% of Heico's spare part sales, so the company doesn't consider that a major threat to its business.
One thing Heico investors don't need to worry about is debt. The company has just $393.4 million in net debt, and despite the COVID-19 crisis, management expects to generate positive cash flow for the remainder of the fiscal year.
Mendelson hopes to take advantage of that balance sheet and depressed valuations in the industry to do some deal-making in the months to come.
"I can tell you we have an appetite, we have the financial capability, and we are active as we can possibly be," he said, also noting that to pass muster, any deal would have to contribute to earnings within the first year.
Heico remains a buy
Heico was one of the top-performing aerospace stocks of the last decade, and the formula that made it successful remains in place and should generate outsize returns over the long term. It operates somewhat as a private equity firm, buying assets with strong cash flow at attractive prices, then streamlining their operations to make them more efficient.
It's the near term that is hard to predict for this company, and though the stock has held up relatively well compared to others in the aerospace sector so far, there could be turbulence up ahead. Heico shares also aren't cheap, trading at an enterprise value of 22.8 times EBITDA. That's a rich premium to similarly well-regarded aerospace supplier TransDigm Group, which trades at a 15.3 multiple.
In my mind, Heico's pristine balance sheet and diverse revenue stream make it worth its premium in this operating environment. I'm not going to predict that it will deliver another 1,280% gain in this decade like it did in the last one, but I do believe investors who buy in now will get an asset that outperforms the market over the long haul.