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In my September 15, 2019 HEICO Corporation (HEI and HEI-a) post, I disclosed the purchase of 300 shares @ ~$99/share in one of the 'Side' accounts in the FFJ Portfolio. Subsequently, I have increased my exposure to 400 shares in a 'Core' account and 400 shares in a 'Side' account.
What initially peaked my interest in this company was this February 19, 2019 Forbes article. After analyzing HEI, I joined Dr. Herbie Wertheim to also create wealth with a long term HEICO investment.
Please read The 47,500% Return: Meet The Billionaire Family Behind The Hottest Stock Of The Past 30 Years before proceeding further. This Forbes article provides a glimpse of the success the Mendelsons have achieved since taking over the company in 1990.
Notes:
- HEICO Corporation has two classes of common stock (HEI and HEI.a). Both classes of shares are virtually identical in all economic respects except voting rights. The difference is that each HEI share is entitled to one vote per share while each HEI.a share is entitled to a 1/10 vote per share. This post focuses on the HEI.a shares (non-voting) since these are the shares I own.
- Do not confuse HEICO Corporation with privately owned The Heico Companies.
I last reviewed HEI in this August 30, 2023 post when it had just released its Q3 and YTD2023 results. Following the release of these results, the share price plunged to ~$126.50 from the previous day's ~$135 close. In reviewing HEI's results, I acquired another 100 HEI.a shares @ ~$127.75 on August 29.
Now, HEI has released its Q4 and FY2023 results following the December 18 market close. This is, therefore, an opportune time to revisit this exiting holding.
Business Overview
HEI's 2022 Annual Report/Form 10-K provides a good company overview.
Additional information is provided in HEI's Investor Presentation and website. The 'subsidiaries' section of HEI's website has a wealth of information about some of the companies HEI has under its umbrella.
Acquisitions are an essential element of HEI's growth strategy. Since 1990, it has completed nearly 100 acquisitions complementing the niche segments of the aviation, defence, space, medical, telecommunications and electronics industries in which it operates. I touch upon HEI's growth through acquisition in my previous post.
As noted in my previous HEI post, HEI serves as a unique opportunity for entrepreneurs looking for additional partners to bring into their company. Because of its history, HEI has become an acquirer of choice because management understands what it is to be an entrepreneur and knows what it is like to operate a small business. It is not a private equity firm looking to sell the business nor is it a large corporate acquirer that will eliminate the essential nature of what made the company successful. HEI strives to maintain the uniqueness and individuality of its businesses to ensure it has passionate people who want to listen to their customers and deliver exactly what the customer needs.
HEI typically targets acquisition opportunities that allow it to broaden its product offerings, services and technologies while expanding its customer base and geographic presence. Even though HEI has pursued an active acquisition policy, its disciplined acquisition strategy involves limiting acquisition candidates to businesses that management believes will continue to grow, offer strong
cash flow and earnings potential, and are available at fair prices.
Historically, HEI quickly integrates its acquisitions. This results in them being accretive to earnings in the year following the purchase.
Acquisitions are generally made using cash provided by operating activities, proceeds from the HEI's revolving credit facility, or the issuance of HEI Class A Common Stock.
Ownership Control
Collectively, HEI's executive officers and entities controlled by them, the HEICO Savings and Investment Plan (401(k) Plan) and members of the Board of Directors beneficially own ~19% of the outstanding Common Stock and ~3% of the outstanding Class A Common Stock. Accordingly, they are able to substantially influence the election of the Board of Directors and control the business, policies and affairs, including HEI's position with respect to proposed business combinations and attempted takeovers.
A high degree of ownership concentration would be of concern if the controlling parties were acting with little regard for the long-term prosperity of the company or other shareholders. Based on my analysis, however, this does not appear to be the case. I see no 'red flags' in how the controlling shareholders manage HEI.
Financials
Q4 and FY2023 Results
HEI's most recently released financial results are accessible in Form 8-K; the Form 10-K has yet to be released.
In my August 30 post, I noted that HEI's leverage jumped following the completion of the Exxelia International acquisition on January 5, 2023.
At the end of Q3 2023 (July 31), the total debt to net income attributable to HEICO ratio had risen to 3.06 and the Net debt to EBITDA ratio had risen to 0.75. On August 4, however, HEI completed the acquisition of the Wencor Group, the largest acquisition in the company's history. As expected, this has led to a surge in HEI's leverage.
The level of the total debt and net debt ratios may be alarming. However, HEI's EBITDA and Net income attributed to HEICO reflect just one quarter of any income generated from the Wencor acquisition. In addition, the FY2023 results reflect the benefit of just 3 quarters of any income generated from the Exxelia acquisition. These events have the effect of distorting HEI's FY2023 net debt calculations.
Management has articulated that both highly synergistic acquisitions are expected to be accretive to earnings within the year following closing. In addition, HEI anticipates that it will continue to achieve its often articulated growth objective in the years after the closing.
One of management's priorities is to restore the total debt to net income attributable to HEI ratio to historically low levels within the next two fiscal years. Investors should, therefore, expect no major acquisitions in the foreseeable future. HEI, however, will continue to actively pursue smaller bolt-on acquisitions from its robust pipeline of acquisition opportunities.
FY2023 Outlook
HEI typically does not provide net sales and earnings guidance. However, management continually states that the company will continue to invest in research and development and execute its successful acquisition program.
Inflationary pressures may lead to higher costs, however, Wencor has yet to be fully integrated. Once fully integrated, some expenses will be lowered.
Encouraging areas of the business are commercial aviation where air travel is recovering. Headwinds, however, are in the high end non aerospace business areas such as high end electronics.
Operating Cash Flow (OCF) Free Cash Flow (FCF)
HEI's FY2023 - FY2011 OCF (in millions of $) is $449, $468, $444, $409, $437, $328, $288, $260, $173, $191, $132, $139, and $126.
Its FY2023 - FY2011 CAPEX (in millions of $) is $50, $32, $36, $23, $29, $42, $26, $31, $18, $16, $18, $15, and $9.
The difference between OCF and CAPEX in FY2023 - FY2011 gives us FCF (in millions of $) of $399, $436, $408, $386, $408, $286, $262, $229, $155, $185, $114, $124, and $117.
Credit Ratings
HEI's domestic senior unsecured long-term debt ratings are:
- Moody's: Baa2 (newly rated as of June 20, 2023)
- Fitch: BBB (newly rated as of June 14, 2023)
Both ratings are in the middle tier of the lower medium-grade investment-grade category. These ratings define HEI as having an adequate capacity to meet its financial commitments. Adverse economic conditions or changing circumstances, however, are more likely to lead to a weakened capacity of the obligor to meet its financial commitments.
*S&P Global does not rate HEI's debt.*
Dividend and Dividend Yield
On December 18, 2023, HEI declared its 91st consecutive semi-annual cash dividend since 1979. Although HEI distributes a small semi-annual dividend (the dividend history is accessible here), an investment in HEI is made primarily for its capital gains potential.
HEI typically leaves its dividend unchanged for 3 consecutive quarters. The recent dividend declaration marks the 3rd consecutive semi-annual dividend at the $0.10 level. I expect a $0.01 dividend increase to be declared in the second half of June 2024 for distribution in mid July.
HEI has had six 5 for 4 stock splits over the years.
The weighted average number of common shares outstanding in the FY2023 - FY2016 timeframe is 138.905, 138.037, 137.854, 137.302, 137.350, 136.696, 135.588, and 133.145 (millions of shares).
Details of HEI's share repurchases commence on page 95 of 133 in the FY2022 10-K; HEI's FY2023 10-K is currently unavailable. Further high-level information is found in the within each Form 10-K and Form 10-Q.
We see from HEI's FY2023 Condensed Consolidated Statements of Cash Flows (page 15 of 16), that share repurchases are negligible and are related to the redemption of common stock related to stock option exercises as opposed to share repurchases on the open market.
Looking at the FY2023 Condensed Consolidated Statements of Cash Flows, we see that HEI issues shares as part of its employee compensation structure. Furthermore, it also issues HEI-a shares to the sellers of many of the companies it acquires thus permitting the sellers to participate in HEI's wealth creation model.
Valuation
HEI's diluted EPS for the FY2023 - FY2016 timeframe is $2.91, $2.55, $2.21, $2.29, $2.39, $1.90, $1.37, and $1.17. The diluted PE for HEI.a shares during the same timeframe is 64, 47, 58.15, 51.12, 37.46, 33.16, 29.55, and 29.65. The valuation is higher for the HEI shares.
When I wrote my August 30 post, HEI had generated $2.17 in diluted EPS in the first 3 quarters of FY2023. I envisioned that it would generate $2.86 in diluted EPS in FY2023.
Based on the current broker-adjusted diluted EPS guidance and my ~$127.75 purchase price on August 29, the following were the forward-adjusted diluted PE levels:
- FY2023 - 12 brokers - mean of $2.90 and low/high of $2.78 - $3.07. Using the mean, the forward adjusted diluted PE is ~44.1.
- FY2024 - 12 brokers - mean of $3.41 and low/high of $3.13 - $3.58. Using the mean, the forward adjusted diluted PE was ~37.5.
- FY2025 - 9 brokers - mean of $4.08 and low/high of $3.75 - $4.40. Using the mean, the forward adjusted diluted PE was ~31.3.
HEI.a's current share price is ~$144. Using the current broker-adjusted diluted EPS guidance, the forward adjusted diluted PE levels are:
- FY2024 - 18 brokers - mean of $3.45 and low/high of $3.01 - $3.86. Using the mean, the forward adjusted diluted PE is ~41.7.
- FY2025 - 15 brokers - mean of $4.10 and low/high of $3.65 - 4.50. Using the mean, the forward adjusted diluted PE is ~35.1.
HEI's EPS, however, is distorted by non-cash Depreciation and Amortization related to multiple acquisitions. Looking at HEI's historical Consolidated Statement of Cash Flows, annual depreciation and amortization were ~$130, ~$96, ~$93, ~$89, ~$85, and ~$77 million in FY2023 - FY2018.
I, therefore, do not rely on HEI's PE levels to determine whether to acquire additional shares. Instead, I try to gauge HEI's valuation using Price/OCF.
Net cash provided by operating activities (in millions) in FY2023 - FY2018 was ~$449, ~$468, ~$444, ~$409, ~$437, and $328.
The weighted average number of common shares outstanding (in millions) in FY2023 - FY2018 was ~139, ~138, ~138, ~138, ~137, ~137, and ~137.
Using these figures, we get OCF/share values of ~$3.23, ~$3.39, ~$3.24, ~$3, ~$3.20, and ~$2.40 for FY2023 - FY2018.
Using the current ~$144 share price and ~$3.23 in FY2023 OCF, the Price/OCF level is ~44.6.
HEI's OCF is generally higher than its EPS. If we conservatively estimate that HEI's FY2024 OCF will be 117% of its $3.45 FY2024 forward adjusted diluted EPS, we should expect HEI's FY2024 OCF to be ~$4.04 (117% x $3.45). Using the current ~$144 share price, the forward Price/OCF level is ~35.6.
Final Thoughts
You can create wealth with a long term HEICO investment if you have a very long term investment time horizon.
I would acquire HEI-a shares as opposed to HEI shares primarily from a valuation perspective. You will only receive one vote for each share owned as opposed to 10 votes for each HEI share. However, you are likely to own so few shares that your votes are irrelevant.
HEI is an ideal investment for a couple of young investors I am helping on their journey to financial freedom. Both young investors are getting a sweetheart of a deal when it comes to their real estate requirements. They will, however, inevitably want to become homeowners.
In FY2023, Canada introduced the First Home Savings Account. These young investors can each contribute $8000 and receive a tax deduction. Do this in 2023 and 2024 and that is a combined $32,000!
Canada also has a Tax Free Savings Account. In 2023, the maximum contribution limit is $6500 and this rises to $7000 in 2024. Contributions to this account are not tax deductible, however, all investments in the TFSA grow tax-free. Maximize the 2023 and 2024 contributions and that is a combined $27,000!
That is a total of $59,000 before:
- any potential appreciation in the value of the investments; and
- BEFORE each investor maximizes their Registered Retirement Savings Plan contributions!
Repeat this process annually and these young investors may be able to 'escape the rat race' at a young age.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long HEI-a. The young investors referenced in this post will initiate a position in HEI-a within the next 72 hours.
Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.
I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with any company mentioned in this article.
