Cliff Note #85 - Hevroux Devtek | $HERXF
A Top 10 Aerospace Company In A Niche Market Segment Revives Margins Through Price Increases and Automation.
This, Cliff Note #85, is the 4th aerospace stock being added to our MSM Index. We get excited when we hear a boring company that has not grown in years say:
“The future for our target market has rarely looked this good”
One of our favorite investing themes is to track established and boring companies that have not grown for years and are about to enter a period of new growth. This growth could last a few quarters or years. These are often companies with market-leading positions and a loyal customer base.
Sometimes the theme or catalyst is company specific, like new products and services, while in other instances, it could revolve around changes going on in a company’s industry.
One of the industry themes we are investing in is aerospace. For example, Boeing and Airbus have backed up orders going out 20 years! Here are a few quotes from Cliff Note 85, relaying a message of strength in the aerospace industry.
According to Boeing's projections, the global aviation industry is expected to require a total of 41,170 new airplanes over the next 20 years in order to meet growing demand and improve the global fleet’s fuel efficiency. Single aisle aircraft are estimated to account for approximately 75% of this total, while widebody aircraft are projected to represent around 18%.”
“In December,Boeing and Airbus, in particular, had a banner month. Airbus set three new industry records including a backlog record (8,598 jets), highest gross orders in a year (2,319 jets), and highest net new orders in a year (2,094 jets). Also, Boeing set a new company all-time backlog record (6,216 jets).”
Here is a sample of some of the key bullish arguments;
Management has taken measures to manage inventory and supply chain issues better so that production can ramp up to meet higher demand.
Margins benefit from increasing product prices to combat inflation and implementing automation. The company is also placing more emphasis on higher-margin aftermarket and maintenance work.
The combined effects of production and margin efficiencies mean the company should be able to grow EPS much faster than revenue.
Estimates point to a consecutive EPS increase in the next 13 quarters (although the rate of growth tapers off in 2027).
The company has been very acquisitive in the past, providing upside to an already rosy forecast. Furthermore, management is communicating that it can deliver higher EBITDA margins in the future, yet analyst estimates don’t bake in much higher margins. (Currently around 15%).
It looks like management sees its industry entering a unique period of accelerated growth (“The future for our target market has rarely looked this good”). The company’s industry, valued at USD 6.7 billion is projected to grow at a CAGR of 7.3% until 2030 (average of 4 industry reports). For additional stats on the overall industry/outlook of global defense and commercial airline sectors, you can reference Cliff Note #78, FTGFF FTG.TO.
The company is showing a record backlog.
If you have not read it yet, please see our “Game Changing Mission Statement” here.
Hevroux Devtek (HERXF)
Themes:
New & Strong Industry Tailwinds - Entering Sustained Period of Accelerated Growth - Margin Expansion
Data:
Founded: 1942
Headquarters: Canada
Exchange: TSX
Symbol: HERXF (OTC) HRV.TO (TSX)
Price: CAD $18.41
Shares Outstanding: 33,653,570
Market Cap: CAD $615M
TTM Revenue: CAD $601M
LT Debt: CAD $192M
Current Portion of LT Debt: $CAD 14.6M
Cash: CAD $6.4M
P/E trailing 12 months: 25.8x
P/E 2024 est: 17.5x
EV/S trailing 12 months: 1.4x
EV/S on 2024 revenue est: 1.3x
What they do:
Heroux Devtek is a company that designs and manufactures aerospace components, particularly landing gear systems.On a side note, TATT, Cliff Note #70, also has a landing gear business.
Product Sales Breakdown:
The company deals only with one type of product category: landing gear systems and components.
Customer & Industry Breakdown:
Around 60% of the sales are attributed to the defense sector, with the other 40% coming from the civil sector. The civil sector contributed the most to improved 2023 results, mainly driven by an increase in deliveries for the Boeing 777 and Embraer Praetor programs. The defense sector witnessed modest growth, mostly from Sikorsky CH-53K and Lockheed Martin F-35 programs.
In the company’s words:
Héroux-Devtek Inc. is an international company specializing in the design, development, manufacture, and repair and overhaul of landing gear, actuation systems, and components for the Aerospace market. The Corporation is the third largest landing gear company worldwide, supplying both the commercial and defense sectors of the Aerospace market with new landing gear systems and components, as well as aftermarket products and services. The Corporation also manufactures hydraulic systems, fluid filtration systems, and electronic enclosures.The Corporation’s emphasis on Research & Development, its systems integration accomplishments, and its engineering prowess are increasingly making Héroux-Devtek a preferred partner for the design, qualification, and manufacture of complete landing gear systems.
Some History:
The company has managed to increase its EPS by 31% in the past three years, maintaining stable EBIT margins amid revenue growth. The current revenue numbers are also higher than pre-pandemic years, which were characterized by inconsistent growth. The COVID pandemic hit the civil aviation industry hard, forcing many aviation companies to find ways to operate more efficiently. Today, the aviation industry (defense and civil) is once again growing, even at higher rates than pre-pandemic levels. This, combined with the fact the company is now operating more officially than ever because of being forced to address lingering problems during the pandemic, positions the company to attain record revenue and earnings per share over the next few years.
Reasons to add to Index:
Management has taken measures to manage inventory and supply chain issues better so that production can be ramped up to meet higher demand.
Margins are benefitting from increasing product prices to combat inflation, as well as implementing automation. The company is also placing more emphasis on higher-margin aftermarket and maintenance work.
The combined effects of production and margin efficiencies mean the company should be able to grow EPS much faster than revenue.
Estimates point to a consecutive EPS increase in the next 13 quarters (although the rate of growth tapers off in 2027).
The company has been very acquisitive in the past, providing upside to an already rosy forecast. Furthermore, management is communicating that it can deliver higher EBITDA margins in the future, yet analyst estimates don’t bake in much higher margins. (Currently around 15%).
It looks like management sees its industry entering a unique period of accelerated growth (“Outside of the immediate headwinds, however, the future for our industry has rarely looked this bright”). The global aircraft landing gear market, valued at USD 6.7 billion, is projected to grow at a CAGR of 7.3% until 2030 (average of 4 industry reports). For additional stats on the overall industry/outlook of global defense and commercial airline sectors, you can reference Cliff Note #78, FTGFF FTG.TO.
Adoption of lighter and more durable landing gear materials is occurring to enhance safety efficiency & reduce maintenance costs. This means that landing gear will be upgraded to modern landing gear at a faster rate than in the past.
Rising procurement of modern generation aircraft, replacement demands, and advancements in aircraft parts, along with increased defense spending, to drive market growth despite safety concerns and potential supply chain disruptions.
The company is increasing its investment in civil aircraft programs. This sector has been the main driver of the recent growth in revenues (increase in deliveries for the Boeing 777 and Embraer Praetor programs) after a steep decline in recent years due to the pandemic.
At CAD$864 million, the company is showing a record backlog that is more than double what it was in 2017 ($405M).
Information about Airbus and Boeing Commercial Aircraft Orders and Deliveries, both clients of Heroux Devtek, confirms strong industry growth tailwinds. In December, both manufacturers and Airbus, in particular, had a banner month. Airbus set three new industry records, including a backlog record (8,598 jets), the highest gross orders in a year (2,319 jets), and the highest net new orders in a year (2,094 jets). Also, Boeing set a new company all-time backlog record (6,216 jets). Airbus is poised to achieve a significant milestone in 2024, with plans to deliver 800 planes, marking a notable uptick in production. This includes the eagerly awaited entry into service of the A321XLR, showcasing the company's commitment to innovation and expansion within the market.
Valuation:
The trailing price-to-earnings ratio stands at 25.8x, which we consider fairly valued. However, we believe the stock can maintain a 25 PE as it continues to grow. Thus, based on 2024 earnings per share estimates, we believe the stock could trade at a price of at least $16 (or CAD$20) per share going forward.
Caveats:
As of 31 December 2023, the company reported very low levels of cash compared to the same period in 2022. The cash reserves went from $ 90 million to $ 6.4 million. This can be explained by the investments in inventory and automation, but it may indicate the debt levels could increase. If we look at the past, we observe a variation in terms of cash reserves, but for the past quarters of 2023, this level has dropped to a historically low.
Another factor to be noted is the fact that the company is highly dependent on the aircraft industry, particularly the civil segment, which can be cyclical.
Héroux-Devtek has a Revolving Facility allowing it to borrow up to $250 million from six banks, with an option to borrow an additional $200 million with lender approval. As of December 31, 2023, $47.0 million was drawn from this facility to invest in inventory for stabilizing production and future sales growth. They also have a Term Loan Facility with Fonds de Solidarité FTQ for $75.0 million, maturing in September 2028. This loan is fully drawn and accrues interest at 5.0%. Repayments can be made starting September 2024, subject to certain fees. As of December 31, 2023, the company's net debt increased to $217.9 million from $165.0 million as of March 31, 2023. This increase is mainly due to cash flow usage for investments. Although profitability improved over the nine-month period, it only partially offset the increase in net debt. (The company seems to be in control of its debt, and the decision to increase it was taken in the context of the inventory plan, so potentially increasing the assets)
Research Tasks:
What are plans to pay down debt?
While EPS growth should be nice for several quarters, revenue growth is not terribly exciting. We would like to know, beyond acquisitions and price increases, if there are plans to accelerate revenue growth.
Would like to gain a better understanding of the maintenance and aftermarket growth opportunity.
What are the company’s ultimate target EBITDA margins?
PR/CC/Filings/Presentations Commentary
Conference Call, February 7, 2024:
“We're pleased to announce that our sales for the last quarter totaled $164 million, a 16.1% increase compared to the same quarter last year, and that brings our trailing 12-month sales above $600 million or representing 98% of our record years in fiscal 2020. This strong group is a sign that our focus on stabilizing our production system is beginning to pay off. The increase in volume, along with the effect of our pricing initiatives in response to inflationary pressure, drove our EBITDA margin up to 15%, marking a significant 500 basis point improvement over last year.Looking beyond this immediate challenge, we see positive long-term dynamics for the aerospace industry. Global traffic is back to pre-pandemic levels, and IATA is forecasting continued growth. The resurgence in travel demand is once again driving new aircraft orders. This, combined with a long-term fleet replacement forecast, is pushing OEMs to increase production rates.Geopolitical tension has also added urgency to the defense industry's effort to maintain, develop and launch new aircraft programs in the United States, the United Kingdom, Western Europe and the Pacific area.”“While we are pleased with our performance this quarter as our return to our historical levels of volume and improvement in profitability has arrived sooner than expected, more work needs to be done. Our focus remains on the execution of our priorities to restore the health of our supply chain, automate manufacturing processes wherever feasible to reduce our cost, and continued our pricing initiatives in response to inflationary pressures.”
Q3 Press Release:
“Looking ahead, the bright outlook of the aerospace market, the business opportunities and the momentum of our strategic initiatives over the next few years allow us to foresee a continued upward trend in sales volume and profitability beyond the sales and margins we have generated in the past.
Industry Report:
“Globally, the civil aircraft backlog stood at 11,8173 at the end of December 2022, a 3.2% decline from the same time last year, but still representing many years of production at current rates. Deliveries totaled 1,185, a 24.6% increase from 2021, as production capabilities improved following the lifting of pandemic restrictions. According to Boeing's projections, the global aviation industry is expected to require a total of 41,170 new airplanes over the next 20 years in order to meet growing demand and improve the global fleet’s fuel efficiency. Single aisle aircraft are estimated to account for approximately 75% of this total, while widebody aircraft are projected to represent around 18%.”
Links
2023 Third Quarter Press Earnings Call: Héroux-Devtek Inc. (HERXF) Q3 2024 Earnings Call Transcript | Seeking Alpha
Industry reports
https://www.polarismarketresearch.com/industry-analysis/aircraft-landing-gear-market
Commercial Aircraft Landing Gear Market Size Report, 2030 (grandviewresearch.com)
Aircraft Landing Gear Market | Market Size, Share, Trend & Forecast Analysis (stratviewresearch.com)
Aircraft Landing Gear Systems Market Size & Demand till 2032 (sanglobalresearch.com)