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HEICO Is A Long Term Wealth Generator

HEICO Corporation's (HEI and HEI.a) total shareholder return over the past decade is very impressive.

Although there is no assurance HEI can replicate what it has accomplished over the past decade, it has demonstrated that it has a winning formula. I am, therefore, willing to 'hitch my wagon to this horse'.

Despite HEI's current lofty valuation, I have increased my exposure with the acquisition of another 200 shares (HEI.a) @ ~$132 on May 23; these shares are held in a 'Core' account within the FFJ Portfolio. The other 400 shares I acquired a few years ago are held in one of the 'Side' accounts within the FFJ Portfolio.

I last reviewed HEI in this December 20, 2022 post at which time it had just released its Q4 and FY2022 results. With the May 22, 2023 release of Q2 and YTD2023 results, I briefly revisit this holding.

NOTE: HEICO Corporation which has two classes of common stock (HEI and HEI.a). Both classes of shares are virtually identical in all economic respects except voting rights. Each HEI share entitles the shareholder to one vote while each HEI.a share entitles the shareholder to a 1/10 vote. I use the HEI.a share price in various calculations in this post.

Business Overview

I encourage you to review HEI's 2022 Annual Report and Form 10-K to gain a good understanding of the company.

Additional information is provided in HEI's Investor Presentation and website.

Growth Through Acquisitions

As mentioned in my prior HEI posts, 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.

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.

In FY2022, HEI completed seven acquisitions with the following bolt-on acquisitions having being made after my May 24 post:

The purchase price of these acquisitions was either paid in cash using cash provided by operating activities, the use of proceeds from the HEI's revolving credit facility, or the issuance of HEI Class A Common Stock. The values of these acquisitions are not material or significant to HEI's condensed consolidated financial statements.

In addition to these smaller acquisitions, HEI closed its acquisition of ~94% of the outstanding shares of leading electronic component maker Exxelia International on January 5, 2023; HEI's management had been analyzing Exxelia for 4 years before announcing July 28, 2022 of its intent to acquire the company. At the time of this announcement, Exxelia was HEI's largest-ever acquisition in terms of purchase price and revenue.

Most recently, HEI announced that it entered into an agreement to acquire Wencor Group from affiliates of Warburg Pincus LLC and Wencor's management for $1.9B in cash and $0.15B in HEICO Class A Common Stock to be paid at closing, or $2.05B in the aggregate. This acquisition is now HEI's largest ever from the perspective of purchase price, revenue and income.

HEI's management expects the Wencor acquisition to close by the end of calendar 2023 and for it to be accretive to HEI's earnings within the year following the closing.

Financials

Q2 and YTD2023 Results

HEI's Q2 and YTD2023 results are accessible in Form 8-K; Form 10-Q has yet to be released.

HEI's leverage has increased significantly because of the recent Exxelia acquisition. Over the years, however, HEI has reduced its leverage fairly quickly thus giving it the ability to continue to make multiple acquisitions.

I do not expect HEI to significantly reduce the current leverage ratios before it acquires Wencor Group in late 2023. Once HEI acquires Wencor Group, I envision the Total Debt to Shareholders' Equity ratio will be above 35% and the Total Debt to net income attributable to HEICO ratio will be above 3. However, I fully expect HEI's leverage ratios will improve significantly over the next couple of fiscal years as management focuses on debt reduction.

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.

Operating Cash Flow (OCF) Free Cash Flow (FCF)

HEI's FY2022 - FY2011 OCF (in millions of $) is $468, $444, $409, $437, $328, $288, $260, $173, $191, $132, $139, and $126.

Its FY2022 - FY2011 CAPEX (in millions of $) is $32, $36, $23, $29, $42, $26, $31, $18, $16, $18, $15, and $9.

The difference between OCF and CAPEX in FY2022 - FY2011 gives us FCF (in millions of $) of $436, $408, $386, $408, $286, $262, $229, $155, $185, $114, $124, and $117.

In the first half of FY2023, HEI generated ~$154.4 million OCF and ~$132.5 million FCF.

All acquisitions are generally accretive to OCF and FCF. Given that the Exxelia and impending Wencor Group acquisitions are two of HEI's largest acquisitions in its history, I envision much higher levels of OCF and FCF in the future.

Credit Ratings

HEI's debt is not rated.

All activities are financed primarily from operating and financing activities, including borrowings under the revolving credit facility. This revolving credit facility contains both financial and non-financial covenants. As of October 31, 2022 (FYE2022), HEI complied with all such covenants.

Borrowings under the revolving credit facility mature in FY2025. When I last reviewed HEI in my December 20, 2022 post, HEI's weighted average interest rate on borrowings under the revolving credit facility as of July 31, 2022 and October 31, 2021, was 3.3% and 1.1%, respectively.

HEI's Q2 Form 10-Q is not yet available. However, we see on page 15 in the Q1 2023 Form 10-Q that as of January 31, 2023 and October 31 2022, the weighted average interest rate on borrowings under HEI's revolving credit facility was 5.5% and 4.6%, respectively. The revolving credit facility contains both financial and non-financial covenants and as of January 31, 2023, HEI complied with all such covenants.

I have no reason to think HEI would offer to acquire the Wencor Group if there was a risk of it going offside on its credit arrangements.

Dividends and Share Repurchases

NOTE: HEI has two classes of common stock: (HEI.a) and (HEI). 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.

Dividend and Dividend Yield

The majority of any potential total investment return is likely to continue to come from capital gains. Investors who fixate on dividend metrics will likely have little if any, interest in HEI.

On December 19, 2022, HEI declared its 89th consecutive semi-annual cash dividend since 1979. I expect the 2nd semi-annual $0.10/share cash dividend to be declared in mid-June for distribution in mid-July.

With the HEI.a shares trading at ~$131, the dividend yield remains below 0.2%.

Stock Splits and Share Repurchases

HEI has had six 5 for 4 stock splits over the years.

The weighted average number of common shares outstanding in the FY2022 - FY2016 timeframe is 138,037, 137,854, 137,302, 137,350, 136,696, 135,588, and 133,145 (millions of shares). The weighted average number of common shares outstanding in the first half of FY2023 is 138,590. The surge in outstanding shares is primarily the result of the issuance of shares related to the Exxelia acquisition.

Details of HEI's share repurchases commence on page 95 of 133 in the FY2022 10-K. Further high-level information is found in the Consolidated Statements of Shareholders' Equity within each Form 10-K and Form 10-Q.

While HEI repurchases shares annually, it also issues HEI-a shares to the sellers of most of the companies it acquires. This permits the sellers to participate in HEI's wealth creation model.

Valuation

HEI's diluted EPS for the FY2022 - FY2016 timeframe is $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 47, 58.15, 51.12, 37.46, 33.16, 29.55, and 29.65.

In contrast, the diluted PE for the FY2022 - FY2016 timeframe for the HEI shares is 60.25, 65.26, 57.82, 47.76, 40.78, 35.37 and 33.69.

In the first half of FY2023, HEI generated $1.43 in diluted EPS. Since this only includes 1 quarter of Exxelia results, I think it is realistic to expect HEI to generate AT THE VERY LEAST, $2.86 in FY2023 diluted EPS.

Using my recent ~$132 HEI.a purchase price, and $2.86 in diluted EPS, HEI.a's forward diluted PE is ~46.2.

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 ~$96, ~$93, ~$89, ~$85, and ~$77 million in FY2022 - FY2018.

Given the magnitude of these non-cash items, I also try to gauge HEI's valuation using Price/OCF.

Net cash provided by operating activities (in millions) in FY2022 - FY2018 was ~$468, ~$444, ~$409, ~$437, and $328.

The weighted average number of common shares outstanding (in millions) in FY2022 - FY2018 was ~138, ~138, ~138, ~137, ~137, and ~137.

Using these figures, we get OCF/share values of ~$3.39, ~$3.24, ~$3, ~$3.20, and ~$2.40 for FY2022 - FY2018.

In the first half of FY2023, HEI generated ~$154.4 of OCF. If I conservatively estimate that HEI will generate ~$460 in OCF in FY2023 and that the current weighted average number of common shares outstanding (in millions) of ~138.6 will increase to 139, the FY2023 OCF/share should be ~$3.31.

As I compose this post, HEI.a and HEI are trading at ~$131 and ~$165, respectively. Using these current share prices and ~$3.31 in projected FY2023 OCF, the Price/OCF levels are:

  • HEI.a: ~40.
  • HEI: ~50.

Adjusted diluted EPS guidance from the brokers which cover HEI is likely to change over the coming days. Using the currently available guidance, however, the following are the forward adjusted diluted PE levels.

HEI-a

  • FY2023 -  14 brokers - mean of $3.01 and low/high of $2.80 - $3.20. Using the mean, the forward adjusted diluted PE is ~43.5.
  • FY2024 -  13 brokers - mean of $3.49 and low/high of $3.10 - $3.75. Using the mean, the forward adjusted diluted PE was ~37.5.
  • FY2025 -  8 brokers - mean of $3.82 and low/high of $3.30 - $4.11. Using the mean, the forward adjusted diluted PE was ~34.3.

HEI

  • FY2023 -  14 brokers - mean of $3.01 and low/high of $2.80 - $3.20. Using the mean, the forward adjusted diluted PE is ~54.8.
  • FY2024 -  13 brokers - mean of $3.49 and low/high of $3.10 - $3.75. Using the mean, the forward adjusted diluted PE was ~47.3.
  • FY2025 -  8 brokers - mean of $3.82 and low/high of $3.30 - $4.11. Using the mean, the forward adjusted diluted PE was ~43.2.

The valuation appears rich but this is typical with HEI.

Final Thoughts

My Final Thoughts are the same as my previous article.

It is reasonable to wonder how HEI has successfully retained its culture and performance excellence given the significant number of acquisitions made over the years. This has been accomplished by giving tremendous authority at the operating level. There are no mid-level Vice Presidents who filter information from the operating companies to senior management.

Before acquiring a company, HEI scrutinizes and analyses the person/people looking to sell their company to HEI. HEI wants to see exactly how these individuals manage their company.

What is also impressive is how HEI treats its employees. As part of HEI's compensation philosophy, it offers healthy base wages and provides additional programs that include annual bonus opportunities, a company-matched 401(k) Plan, healthcare and insurance benefits, health savings and flexible spending accounts, paid time off, family leave, flexible work schedules, and employee assistance programs.

On the Q4 2022 earnings call, the company's Chairman stated that many employees (shipping clerks, factory workers, secretarial help) are millionaires/multimillionaires because of the HEI shares given to them over the years. Despite this level of wealth, these employees continue to work at HEI because they take pride in being HEI team members.

This is an extremely well-managed company with annual revenue having grown from $0.897B in FY2012 to $2.208B in FY2022. With the acquisition of Exxelia and the impending acquisition of the Wencor Group, it seems reasonable to expect HEI to double its revenue within the next 5 - 8 years and to continue to be profitable and generate strong cash flow.

While no rating agency covers HEI, the company typically employs a conservative level of debt. HEI's leverage ratios are elevated relative to historical levels and will likely remain elevated for the next couple of years given the size of the Exxelia and the Wencor Group acquisitions. However, HEI is a conservatively managed company and I expect the leverage ratios to return to recent historical levels within the next 3 - 4 years.

Investors should also consider that the controlling shareholders have a vested interest in ensuring that what is likely their largest asset becomes increasingly more valuable.

I once again provide the following links so you learn about the evolution of HEI.

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.

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.