Buy Héroux-Devtek for aviation exposure, this investor says

Dropping into a steep nosedive at the start of the pandemic, Canadian aerospace company Héroux-Devtek (Héroux-Devtek Stock Quote, Charts, News, Analysts, Financials TSX:HRX) has done an admirable job over the past year and a half of gaining altitude but the stock is still below its pre-pandemic highs. Where’s HRX headed from here? Portfolio manager Colin Stewart thinks the imminent comeback in commercial aviation means it’s up into the wild blue yonder for Héroux-Devtek.

“We still own Héroux-Devtekthink. It’s a very well-operated company,” said Stewart, CEO of JC Clark Limited, who spoke to BNN Bloomberg about Héroux-Devtek in a segment on Tuesday. 

“It focuses in the aerospace sector, particularly on landing gear. And we think with the recovery both in commercial airline demand that part of their business is going to do well, [but] they have a very strong defence segment as well, which has helped the business hold up pretty well during the pandemic,” he said.

The third-largest landing gear manufacturer in the world, Longueuil, Quebec-headquartered Héroux-Devtek had a rough 2020 as business slowed down in the wake of COVID lockdowns and the suspension of air travel both domestic and international. The company closed its Alta Precision plant in Anjou, having just acquired the business a year earlier, and shed over 200 jobs in the process, about ten per cent of its workforce.

The company reported a loss of $1.3 million for its fiscal first quarter 2021, delivered mid-last year in August, with revenue down 10.5 per cent to $128.3 million. The difference between HRX’s twin segments in civil aviation and defence was easy to see in that quarter, where civil sales dropped by 26 per cent year-over-year while defence actually went up three per cent.

Management pointed to the company’s strong backlog, which stood at $772 million at the time, as a cause for optimism.

“Our first quarter results were encouraging given this turbulent environment. We remained profitable and generated free cash flow that are helping us maintain a healthy balance sheet. The restructuring measures we announced in May are also proceeding according to plan,” said Martin Brassard, President and CEO of Héroux-Devtek, in an August 7, 2020, press release.

Fast forward twelve months and things still looked to be in recovery mode, with sales for the company’s Q1 fiscal 2022 down to $126.2 million compared to $128.3 million the year before. Again, the issue was a lagging Civil segment, as Defence revenue rose 21.5 per cent year-over-year. The Q1 adjusted EBITDA was an improvement, hitting $20.0 million or 15.9 per cent of sales compared to $18.4 million or 14.3 per cent a year earlier.

“We continue to see the future with prudent optimism given our diversified product portfolio and the flexibility we can derive from our strong financial position. Once the civil aerospace market recovers, we will be ready to absorb the resulting growth within our current production structure,” said Brassard in an August 10 press release.

Also encouraging was management’s decision to start a share buy-back program earlier this year involving up to ten per cent of the public float of just over 24 million shares, with Brassard saying the move related to the company’s stock price, which at the time of the announcement in May was still down about 12 per cent from pre-pandemic levels.

“Recognizing that our share price does not reflect the full underlying value of Héroux-Devtek, we announced today our decision to initiate a normal course issuer bid to optimize our capital allocation with the objective to unlock stronger returns for our shareholders, without compromising our position for future growth initiatives,” Brassard said in a May 20 press release.

Stewart said the return of air travel is inevitable and HRX’s strengths make it a good bet in the sector.

“It trades at a pretty big discount to its peers, and we think this management team has historically been very good capital allocators. We wouldn’t be surprised if they do things like make another acquisition at some point and look at ways of creating shareholder value,” Stewart said. “So, it’s still a core position for us.”

“I’m not that concerned [about air travel]. Héroux-Devteck is one of the experts in that the landing gear segment and particularly on the defence side, which is about 65 per cent of their business. The demand for that part of the business has remained strong all the way through the pandemic. Obviously, the other segment, the commercial side where less people are flying on airplanes right now, that business has been impacted to some degree,” he said.

“But landing gear is an essential component for any airline and certainly we’re strong believers that commercial travel is going to rebound.” Stewart said. “We think the long-term demand for for airline travel and therefore commercial planes is going to be quite strong. I think Héroux-Devtek is a good business and is poised to do very well.”