HEICO Flying

By Stephen D. Simpson, CFA | December 17, 2010 AAA

Sometimes it pays for investors to turn over a lot of rocks. Aerospace parts and electronic components maker HEICO (NYSE:HEI) does not get a lot of attention and seldom makes the headlines of the major financial press, but that has not kept the company from doing a consistently good job of generating returns on capital or overall growth. With the airline industry in better health these days, investors have taken notice of HEICO's positive qualities and pushed the stock up more than 75% over the past year.

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Another Good Quarter
HEI delivered a solid end to its fiscal year, with quarterly revenue growth of about 18% that topped the high end of analyst estimates. The company's flight support business (the parts business) saw top line growth of 14%, while the electronic technologies division posted 27% reported growth and 7% organic growth. There was no real magic bullet to the growth in this quarter, rather it was more a product of improving markets and the company's execution.

HEI also did well in moving that extra revenue through to higher profitability. The company saw gross margin improve by more than 200 basis points, though higher SG&A spending depleted some of that benefit. Overall, operating income rose 23% for the quarter, as operating margin improved by about 70 basis points. Growth was relatively balanced between the two segments (flight support up 28%, electronics up 20%), though the electronics business is much more profitable as a percentage of sales. (For more, see The Bottom Line On Margins.)

Conditions Keep Getting Better
HEI seems to be benefiting from a combination of more capacity in the airline industry and more willingness on the part of commercial airlines to spend on non-essential maintenance, repair and overhaul (MRO). What is interesting is that the engine parts business has been improving faster than the interior cabin business - suggesting perhaps that airlines are still most focused on mission-critical maintenance and acting a little more slowly on less essential repairs. Given a relatively recent flight I took on a major commercial airline where half of the seats were broken or in some state of disrepair, that would seem to fit those business conditions.

All in all, though, HEI is well-positioned for this recovery in the aerospace business. The company works with virtually every major airline as a parts supplier, but has deeper strategic relationships with airlines like AMR (NYSE:AMR), Delta (NYSE:DAL), British Airways (NYSE:BAIRY) and JAL where the companies work together to determine the need for parts and whether HEI can make a given part for less than the original manufacturer. Given that HEI's parts often offer savings up to one-third from the OEMs, those can be compelling relationships for both parties. (For related reading, see Will Airlines Continue To Soar.)

Of course, that is not lost on the OEMs, either. General Electronic (NYSE:GE) has been more aggressive about trying to defend its lucrative parts business, and United Technologies (NYSE:UTX) and Rolls Royce are not eager to cede any additional business either. Fortunately for HEI, the company not only has a reputation for cost-effective quality, but also a relationship with Lufthansa Technik - one of the largest aircraft MRO providers.

The Bottom Line
Given the expected ongoing recovery in commercial aerospace, to say nothing of the strong stock performance over the past year, HEI shares seem to be trading about where they should. The company has a relatively clean balance sheet, though, and a history of doing accretive bolt-on acquisitions. While getting another boost of growth from some deals is not out of the question for the next year, value-oriented investors probably want to keep this one on the watch list for now and hope to exploit some turbulence in the future. (For more, see All Airlines At Full Throttle.)

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