Liberty Posted February 4, 2015 Share Posted February 4, 2015 Thanks to moatsandvalue for mentioning it in the Transdigm thread. I had a quick look and thought we might as well have a thread for it. Didn't take a deep dive yet, but it seems interesting. It's an aerospace manufacturer and distributor (not just for planes, but also satellite stuff, etc), mostly operating in various niches. Doesn't seem to have the focus on sole-source that TDG has, and their margins are a fair bit lower because of it, but at least the focus on niches and equipment that saves money to their customers through higher efficiency puts them in a fairly good competitive position. They've been compounding at very high rate for a few decades (around 20% for past 10-15 years, even higher in past 5 years), with FCF being much higher than earnings (over 150% in recent times). Most of it seems to be redeployed in M&A, as well as in regular and special dividends. They seem fairly prudent with debt (debt-to-EBITDA at 1.23x), though not focusing on sole-source stuff where there's literally no competition, I don't think they could pull off safely the kind of gearing that TDG has. The current CEO has been there since the early 90s, is 75, and owns 8%. His sons (I'm assuming -- same names, 46 and 48 years old) run the two main divisions and each own about 4%. Total insiders own 25% of the business. They've been paying semi annual dividends since 1979 without missing one. They just increased it 17%. One strange thing is that the HEI.a shares sell for a significant discount over the HEI common despite the only difference being that the .a has 1/10th the votes (47 vs 62). Certainly not something you see with the Malone companies, where the C shares with no votes often trade at par or above the class A... "No one customer accounted for more than 10% of net sales and our top five customers represented approximately 17% of consolidated net sales." You can see the company history here: http://www.heico.com/about-us/who-we-are/our-history/ Here are their subsidiaries to give you an idea of the kind of things that they make: http://www.heico.com/about-us/subsidiaries/ ROIC with Greenblatt's method is pretty strong (mid 50s for past few years, barely dipped below 40 in 2009). HEI.a is selling for about 18.5x TTM FCF, which isn't cheap, but might not be expensive if the business is as good quality as it seems on first glance. As I said, this isn't a deep dive. I just spent a couple hours on it, so there might be tons of stuff I'm missing (maybe including big cockroaches). I just found it interesting enough to create a thread and see if others an opinions on it. Cheers. Link to comment Share on other sites More sharing options...
Liberty Posted February 25, 2015 Author Share Posted February 25, 2015 Nobody seems to give a crap. But this got cheaper today. Link to comment Share on other sites More sharing options...
berkshire101 Posted February 25, 2015 Share Posted February 25, 2015 I give a crap, but it seems rather expensive still. Link to comment Share on other sites More sharing options...
Liberty Posted February 25, 2015 Author Share Posted February 25, 2015 I give a crap, but it seems rather expensive still. Out of curiosity, what multiple of FCF would you consider paying for it? Link to comment Share on other sites More sharing options...
berkshire101 Posted February 25, 2015 Share Posted February 25, 2015 I give a crap, but it seems rather expensive still. Out of curiosity, what multiple of FCF would you consider paying for it? The business earns about 13-15% return on capital. So on paper that's how much book value (including dividends paid and share repurchases) would grow by over the long-term. If I'm happy with 13-15% annualized returns over the long-term then I would pay around 15-17 times free cash flow. It's trading for around 23 times I believe. What about you Liberty? Link to comment Share on other sites More sharing options...
Liberty Posted February 25, 2015 Author Share Posted February 25, 2015 I give a crap, but it seems rather expensive still. Out of curiosity, what multiple of FCF would you consider paying for it? The business earns about 13-15% return on capital. So on paper that's how much book value (including dividends paid and share repurchases) would grow by over the long-term. If I'm happy with 13-15% annualized returns over the long-term then I would pay around 15-17 times free cash flow. It's trading for around 23 times I believe. What about you Liberty? I didn't redo the math, but when I first looked to write the original post of this thread, HEI.a was selling for about 18.5x TTM FCF. Probably a bit lower than that now (HEI is more expensive than HEI.a despite only difference is having votes). They've been growing FCF/share at around 20% CAGR for 10-15 years (faster than that past 5 years). IMO Paying under 18x FCF for that isn't very expensive. But as I said, I prefer TDG. I think the traditional ROIC calculation can be misleading for these types of businesses. TDG only has low teens ROIC, but they have goodwill that doesn't need to be replaced and one-time restructuring charges, etc. This muddies the picture. If you look at Greenblatt's ROIC measure instead, HEI is closer to 55% returns and TDG is in the 120-130% range. That doesn't tell you what your return will be (IMO FCF/share growth is a better measure of that), but it tells you a lot about the quality of the underlying business if you put aside some of the noise. Link to comment Share on other sites More sharing options...
rb Posted February 25, 2015 Share Posted February 25, 2015 I just did the calc and for HEI.a I get FCF of about 150 Mn which means that the company is going for about 22x FCF. The financials look clean and it's a lot less levered than TDG. Maybe they're being more conservative because the family owns so much of it and would like to stay rich. Probably the same reason why you don't see a lot of stock dilution. They seem to have been able to make a lot of money on the acquisitions. Are they just good investors/operators or is there something else? Maybe some juicy defense contracts or something as well? Link to comment Share on other sites More sharing options...
berkshire101 Posted February 25, 2015 Share Posted February 25, 2015 Also, isn't the aerospace industry cyclical? Right now, we're in an up cycle so valuation tend to be higher. So maybe there will be reversion to the mean and HEI will become a bargain. Link to comment Share on other sites More sharing options...
Liberty Posted February 25, 2015 Author Share Posted February 25, 2015 Also, isn't the aerospace industry cyclical? Right now, we're in an up cycle so valuation tend to be higher. So maybe there will be reversion to the mean and HEI will become a bargain. With these businesses (though I know TDG better), the money is made on the aftermarket parts. As long as planes and helicopters fly, you need the parts. One of the reasons why I prefer TDG is that almost all their stuff is sole-source, hence no competition and EBITDA margins of close to 50% :) Link to comment Share on other sites More sharing options...
Liberty Posted February 25, 2015 Author Share Posted February 25, 2015 I just did the calc and for HEI.a I get FCF of about 150 Mn which means that the company is going for about 22x FCF. The financials look clean and it's a lot less levered than TDG. Maybe they're being more conservative because the family owns so much of it and would like to stay rich. Probably the same reason why you don't see a lot of stock dilution. They seem to have been able to make a lot of money on the acquisitions. Are they just good investors/operators or is there something else? Maybe some juicy defense contracts or something as well? I was getting closer to 175m FCF TTM, but I just did it quickly so maybe I'm wrong. Link to comment Share on other sites More sharing options...
Jurgis Posted February 26, 2015 Share Posted February 26, 2015 Yeah, we give a crap. I just haven't had time to look at it yet. 8) Thanks for bumping it up periodically. Actually, don't bump it up. I'd prefer cheaper shares. :P Link to comment Share on other sites More sharing options...
Guest Schwab711 Posted February 26, 2015 Share Posted February 26, 2015 I give a crap, but it seems rather expensive still. Out of curiosity, what multiple of FCF would you consider paying for it? The business earns about 13-15% return on capital. So on paper that's how much book value (including dividends paid and share repurchases) would grow by over the long-term. If I'm happy with 13-15% annualized returns over the long-term then I would pay around 15-17 times free cash flow. It's trading for around 23 times I believe. What about you Liberty? This quote is of particular interest to me (as you can tell by past comments) because I have been working on research for quite awhile that deals with long-run market returns and predictions of causes, price multiplies vs. ROIC (the goal is to get an idea of FV for quality companies), and a few other return-related problems. I'm not sure if you have a formula to get your 13%-15% => 15 - 17x FCF conversion but, the best I can tell so far, a price multiple paid only matters relative to what it will be at the time of your sale (for total returns realized; this is only for cases where your exit strategy is on equivalent or better exchange and your stake is trivial vs. avg volume). So 18x FCF is not necessary good or bad multiple, it's only good or bad relative to your xPM (price multiple) when sold (which is why people look at historical P/E multiples). A lot of people assume stocks will trend to 15x (again, best I can tell, most will not over any sufficient amount of time (sectors vary considerably); but the overall average will likely be around 15x in the long-run), but this mostly has to do with over-looked assumptions in research done by profs/academics who have found long-run returns to be 6%-7% over any sufficient time period [which conveniently => 14.3x - 16.7x market PM]. This is a really amazing industry that correlates very highly with airline miles flown for customers of those companies. Airline flights have decreased in real costs pretty consistently for decades (and seem poised to continue to do so) so airline miles flown have pretty consistently increased over time, seemingly independent of the health of the overall economy. This should drive revenue growth for sole-source parts (assuming those planes continue to be flown - not worth worrying about for TDG at least). tl;dr: 18x FCF is really cheap imo if Heico has anything near TDG's sole-source revenue % (haven't research at all yet). TDG is fone of my favorite companies though, same tier as FICO, V/MA, MCO for me. No more bumps from me :) Link to comment Share on other sites More sharing options...
Liberty Posted February 26, 2015 Author Share Posted February 26, 2015 Very good post, Schwab. The whole revenue-passenger-mile story + aftermarket + sole-source dynamic is incredible, in my opinion. Heico sadly doesn't have the amount of sole source that TDG does (I couldn't find the exact ratio, but they clearly don't focus on it as much, and their lower margins are probably a proxy for that), but it's still worth a look. Heico is one of my second-tier ideas, but I wanted to share it anyway. I just thought it was too bad when tumbleweeds blew through this thread because I was curious to hear what others thought, and figured maybe they could make me see things that I had missed about the company. Link to comment Share on other sites More sharing options...
yadayada Posted February 26, 2015 Share Posted February 26, 2015 isn't rolls royce much cheaper? Or why not buy both for that matter? Link to comment Share on other sites More sharing options...
Liberty Posted February 26, 2015 Author Share Posted February 26, 2015 isn't rolls royce much cheaper? Or why not buy both for that matter? Does their FCF/share numbers over the past decade look good to you? These capex numbers are enough to scare me... Link to comment Share on other sites More sharing options...
berkshire101 Posted February 26, 2015 Share Posted February 26, 2015 I give a crap, but it seems rather expensive still. Out of curiosity, what multiple of FCF would you consider paying for it? The business earns about 13-15% return on capital. So on paper that's how much book value (including dividends paid and share repurchases) would grow by over the long-term. If I'm happy with 13-15% annualized returns over the long-term then I would pay around 15-17 times free cash flow. It's trading for around 23 times I believe. What about you Liberty? This quote is of particular interest to me (as you can tell by past comments) because I have been working on research for quite awhile that deals with long-run market returns and predictions of causes, price multiplies vs. ROIC (the goal is to get an idea of FV for quality companies), and a few other return-related problems. I'm not sure if you have a formula to get your 13%-15% => 15 - 17x FCF conversion but, the best I can tell so far, a price multiple paid only matters relative to what it will be at the time of your sale (for total returns realized; this is only for cases where your exit strategy is on equivalent or better exchange and your stake is trivial vs. avg volume). So 18x FCF is not necessary good or bad multiple, it's only good or bad relative to your xPM (price multiple) when sold (which is why people look at historical P/E multiples). A lot of people assume stocks will trend to 15x (again, best I can tell, most will not over any sufficient amount of time (sectors vary considerably); but the overall average will likely be around 15x in the long-run), but this mostly has to do with over-looked assumptions in research done by profs/academics who have found long-run returns to be 6%-7% over any sufficient time period [which conveniently => 14.3x - 16.7x market PM]. @Schwab: I've been working on some research myself relating to ROIC and future returns. Maybe we can discuss a bit more? If so, let me know and I'll send you a PM! :) Link to comment Share on other sites More sharing options...
Liberty Posted February 26, 2015 Author Share Posted February 26, 2015 Berkshire101, have you read the book "Valuation" (5th ed.) published by McKinsey? I found really interesting things about how to think about ROIC and growth in there. Link to comment Share on other sites More sharing options...
berkshire101 Posted February 26, 2015 Share Posted February 26, 2015 Berkshire101, have you read the book "Valuation" (5th ed.) published by McKinsey? I found really interesting things about how to think about ROIC and growth in there. No I haven't. Thanks for pointing it out. I'll take a look see. By the way, what did you find interesting about ROIC and growth? Link to comment Share on other sites More sharing options...
Liberty Posted February 26, 2015 Author Share Posted February 26, 2015 Berkshire101, have you read the book "Valuation" (5th ed.) published by McKinsey? I found really interesting things about how to think about ROIC and growth in there. No I haven't. Thanks for pointing it out. I'll take a look see. By the way, what did you find interesting about ROIC and growth? Not easy to summarize right now, and I'd have to go over my notes to see what came from that book (because I've incorporated it into how I generally view things, but some things came from other places, and I have my own take on it). I just remember finding it really interesting and well explained (very systematic approach). If the topic interests you, I think it's pretty safe that you should enjoy it, unless you are already so advanced and your study of ROIC is so esoteric that you'll find the book too basic... But that's for you to decide. Link to comment Share on other sites More sharing options...
Liberty Posted May 28, 2015 Author Share Posted May 28, 2015 Looks like Arlington Value (Meecham) has opened a small position in Heico. Link to comment Share on other sites More sharing options...
Chalk bag Posted May 28, 2015 Share Posted May 28, 2015 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. Link to comment Share on other sites More sharing options...
fisch777 Posted May 28, 2015 Share Posted May 28, 2015 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. Link to comment Share on other sites More sharing options...
big_triece Posted September 24, 2015 Share Posted September 24, 2015 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. Link to comment Share on other sites More sharing options...
marazul Posted October 8, 2015 Share Posted October 8, 2015 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." Link to comment Share on other sites More sharing options...
giofranchi Posted October 8, 2015 Share Posted October 8, 2015 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 Link to comment Share on other sites More sharing options...
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