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Is Heico Stock a Buy?

There are many things to like about aerospace, defense, and electronic products company Heico (NYSE: HEI). Its commercial aerospace exposure makes it a desirable growth play in a market that looks set for a multiyear recovery once the pandemic threat recedes. Meanwhile, its non-commercial aviation businesses (around 60% of revenue in 2020) give it some insurance against the downside should that anticipated rebound, for whatever reason, not materialize. Does it all add up to make Heico stock a buy? Let's take a closer look.

Image source: Getty Images.

How Heico makes money

The company operates in two segments. The flight support group (FSG) designs and manufactures Federal Aviation Administration-approved jet engine and aircraft replacement parts. As such, the FSG's primary competitors are the original equipment manufacturers (OEM).

It's a great market to be in as Heico can offer parts at lower prices than the OEMs. Moreover, since getting FAA approval for parts is not easy, Heico still has a competitive moat. That combination of factors has helped the company to produce remarkable growth in revenue and income over the years.

Data by YCharts

The flight support group also repairs, overhauls, distributes parts, and manufactures and sells specialty parts for OEMs and the U.S. government.

The electronic technologies group (ETG) manufactures and sells electronic components to military agencies and defense contractors. It's primarily a defense business, but it sells to commercial satellite and spacecraft manufacturers, too. The ETG tends to be a higher-margin business, with an operating income margin of nearly 30% compared to the FSG, which sports margin percentages in the high teens.

Heico in 2020

As you can see from the table below, the electronic technologies group's revenue grew by 4.8% in 2020 (as its operating income rose 5.3% to $259 million), which helped support the company through a tough year. In comparison, the flight support group's revenue declined by more than 25%, with operating income down by a whopping 41%.

Heico Segment

2020

2019

Change

FSG: Aftermarket replacement parts revenue

$526 million

$678 million

(22.5%)

FSG: Repair and overhaul parts and services revenue

$193 million

$299 million

(35.5%)

FSG: Specialty products revenue

$206 million

$263 million

(21.6%)

Total FSG Revenue

$925 million

$1.24 billion

(25.4%)

ETG: Defense, space, and aerospace revenue

$680 million

$634 million

7.3%

ETG: Other industries revenue

$195 million

$201 million

(2.9%)

Total ETG Revenue

$875 million

$835 million

4.8%

Data source: Heico presentations.

The investment case for Heico

The case for buying Heico stock rests on three key arguments.

First, its balance sheet is strong, with no significant debt maturities until 2024 and a low net-debt-to-EBITDA ratio of 0.6. (A ratio of 2.5 or below is typically seen as worthy of investment-grade debt by rating agencies.) As such, Heico plans to "aggressively pursue high-quality acquisitions," said CEO Laurans Mendelsohn on the company's February earnings call.

It's a strategy in line with the company's history of growth by acquisition, and will allow it to take advantage of the current environment and emerge stronger as commercial air traffic recovers.

Image source: Getty Images.

Second, the FSG's revenue should embark on a multiyear recovery as more aircraft get flown, lifting demand for aftermarket parts and repairs. Also, Heico's position as a lower-cost supplier means that it's likely to benefit in an outsized way from that increased demand as financially stressed airlines become more focused on seeking the best prices on replacement parts.

Third, the defense-heavy ETG tends to have higher margins than the FTG. It will continue to provide support for the FSG as it recovers, and also the financial muscle for acquisitions.

In a nutshell, if you believe in Heico's business model -- one that's proven to be wildly successful over the years -- and you believe that a multiyear recovery in commercial aerospace is in the offing, it's a short jump to the conclusion that this company will produce strong post-pandemic performance.

Is Heico a buy?

That said, there are a few reasons for caution about this stock. There's the possibility that the OEMs will get more aggressive on pricing their parts and repair services. The smaller independent service companies could get more aggressive too, not least because the total market is smaller than it was in 2019.

There's also the fact that Heico's valuation multiples are higher than they were going into the pandemic. While this reflects the company's growth potential, the Wall Street consensus forecast is that Heico will generate $500 million in free cash flow (FCF) in 2023. Based on its current market cap of $16.7 billion, it won't be until 2023 that Heico is trading at 33 times its FCF.

Data by YCharts

Finally, even if you are bullish about the prospects for a commercial aerospace market recovery, you still have to make the case that Heico is one of the best ways to play that investment theme. Given its rich-looking valuation and the variety of other options available, now might not be the best time to invest in the stock.

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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool recommends Heico. The Motley Fool has a disclosure policy.


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