In a difficult year for commercial aerospace stocks, Heico (NYSE:HEI) has been a relative outperformer. The stock is down 17% year to date, ten percentage points better than the iShares U.S. Aerospace & Defense ETF and 30 percentage points better than Boeing (NYSE:BA).
Heico's unique product mix has allowed it to hold up better than most as the COVID-19 pandemic weighed on global travel demand and caused airlines to cut costs. Wall Street has noticed, with Heico valued at more than 6 times sales compared to Boeing's 1.4 times sales valuation.
Heico's a good company but no bargain. And the headwinds rippling through commercial aviation and aerospace are expected to stay with us for years, potentially limiting the near-term upside. Here's a look at Heico's business and its outlook for the future to determine whether the company is a buy today.
Heico's diversity has kept it strong
Heico is best known as a maker of aerospace components with a focus on the aftermarket, or selling replacement parts to operators instead of new parts to manufacturers. The company has used a steady stream of acquisitions to grow, more than quadrupling its revenue in the last decade.
The results have been impressive, with the stock among the top aerospace performers of the last decade with a 1,280% return.
But it has been Heico's non-commercial aerospace business that has helped the company hold up during the pandemic. The company generates about half of its sales from defense, space, medical, and electronics end markets, and those businesses have offset some of the commercial weakness.
Heico makes components that go into CT scanners, X-ray machines, and other in-demand medical applications, and many of its defense customers were exempted from local shelter-in-place orders and needed a continued stream of parts.
Even prior to the pandemic, Heico's non-commercial businesses were growing faster and posting better margins. The company's commercial aerospace assets, housed in its flight-support group, reported 2019 revenue growth of 13% and generated net income equal to 19.5% of sales. Its electronics segment, by comparison, grew sales by 19% last year and reported net income that was 29.4% of total sales.
How quickly will aerospace rebound?
The non-aerospace business has helped cushion the blow, but it is hard to imagine Heico repeating the sort of outperformance it enjoyed in the last decade until the airlines return to growth mode. Boeing expects it to take years for new jet sales to recover from the pandemic, but there is reason for Heico to hope its business will recover faster than Boeing's.
Airlines have raised billions in new debt to stave off bankruptcy, and their balance sheets will take years to recover. In the meantime, they are likely to lean heavily on their existing fleets, which should mean a rebound in the aftermarket well ahead of a surge in new jet sales.
During a May investor call, Heico Chairman and CEO Laurans A. Mendelson laid out the bull case for a quick recovery:
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 how 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.
That remains to be seen, but I do expect Heico and other aftermarket-focused suppliers like TransDigm Group to rally ahead of Boeing or new equipment-focused suppliers like Spirit AeroSystems.
Is Heico worth the wait?
Heico is among the best-run companies in aerospace and will likely over time continue its track record of superior performance. For those interested in adding commercial aerospace to their portfolios today, there is no better company to buy.
That said, right now I don't see a reason to rush to add any commercial aerospace companies -- even Heico -- to my portfolio. It seems possible that commercial-focused stocks will be stuck in neutral for a year if not longer. With so many other sectors of the economy likely to recover more quickly, including more defense-focused aerospace heavyweights, there are better places to put your money today.
We'll get a better idea of how Heico is holding up in late August when the company is expected to release quarterly earnings. Perhaps those results will show I'm being overly pessimistic about a proven winner. But until we see a firm sign of a recovery, I would hold off buying into Heico shares.