Pat McKeough responds to many personal questions about stock investing and other investment topics from the members of his Inner Circle. Every week, his comments and recommendations on the most intriguing questions of the past week go out to all Inner Circle members. And each week, we offer you one of the highlights from these Q&A sessions. While we reserve our buy-hold-sell advice for Inner Circle members, these excerpts provide a great deal of information and analysis on stocks we’ve covered for members of Pat’s Inner Circle.
This week, one Inner Circle member wanted to know about Héroux-Devtek. This Canadian company has carved out a special niche for itself in the aeronautical business. Pat balances the drawbacks of operating in a highly cyclical industry against the company’s long-term contracts with military and commercial clients.
Q: Could I have your opinion on a company called Héroux-Devtek? I believe they make landing gear for many airplanes.
A: Héroux-Devtek Inc. (symbol HRX on Toronto; www.herouxdevtek.com), is the world’s third-largest maker of landing gear for aircraft, particularly helicopters and small jets.
The company also makes metal enclosures for airborne radar and other electronic equipment. Its commercial customers include Boeing, Sikorsky, Bombardier and Embraer. The company also sells its products to military clients. Héroux-Devtek gets about 70% of its sales from outside Canada.
In August 2012, Héroux-Devtek sold its Aerostructure (parts for wings and fuselages) and Industrial Products (power-generator components) businesses for $232.0 million. The sale will let the company focus on its landing gear operations.
Héroux-Devtek earned $2.7 million from its ongoing operations in its 2013 second quarter, which ended September 30, 2012. That’s up 9.8% from $2.5 million a year earlier. Earnings per share rose 12.5%, to $0.09 from $0.08, on fewer shares outstanding. Sales rose 4.0%, to $57.7 million from $55.5 million.
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Sale of two businesses allows Héroux-Devtek to pay down debt and declare special dividend
Héroux-Devtek used part of the proceeds from Aerostructure and Industrial Products sale to pay down $54.0 million of its debt, bringing its total debt down to $60.5 million on September 30, 2012. That’s a low 15.1% of its market cap. It also held cash of $291.3 million, or $9.45 a share.
The company will also use the sale proceeds to pay for its recently announced special dividend.
In November 2012, Héroux-Devtek declared a special dividend of $5.00 a share, payable on December 19, 2012. Because the amount of this one-time payout exceeds 25% of the company’s current stock price, the Toronto Stock Exchange requires the shares to trade on a “due bill” basis. This means that all buyers of the stock until the close of markets on December 19, 2012, were entitled to the special distribution.
The dividend consists of a regular payment of $2.30 plus a return of capital of $2.70. In this case, the return of capital portion is tax-deferred: shareholders are only liable for capital gains taxes when they sell their shares. At that time, the return of capital lowers the adjusted cost base of the original share purchase—triggering a capital gain.
The special dividend will cut Héroux-Devtek’s cash holdings by around $160 million. The company does not pay a regular dividend.
Héroux-Devtek will probably earn $0.60 a share in 2013. The stock trades at 21.2 times that estimate. Héroux-Devtek maintains a reputation for quality and holds long-term contracts with major customers. As well, the company could become a takeover target for a larger aerospace firm. That’s not reason enough on its own to buy the stock, but it adds appeal.
In the Inner Circle Q&A, Pat looks at Héroux-Devtek’s price-to-earnings ratio, which is high for a company closely tied to the very cyclical commercial aircraft industry. He also considers the possibility that demand from military customers could suffer if governments cut defence spending in response to rising budget deficits. He concludes with his clear buy-hold-sell advice on the stock.
COMMENTS PLEASE—Share your investment experience and opinions with fellow TSINetwork.ca members
Do you look for stocks that have a specialty that gives them a special niche in their field, like Héroux-Devtek? Roughly how much of your portfolio are you willing to devote to potentially more volatile stocks like these? Let us know what you think.
Comments
Alan
It looks to me like the company had grown too big for the current management to be comfortable with, they received an offer they could not refuse for a portion of the firm, and they decided to downsize.
This is not a company I want to invest in. Though they appear to have the management skill needed to grow the firm, they don’t have the drive. This is a firm I would rather buy, than invest in.
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X No, I don’t want to make big money in the stock market.
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It looks to me like the company had grown too big for the current management to be comfortable with, they received an offer they could not refuse for a portion of the firm, and they decided to downsize.
This is not a company I want to invest in. Though they appear to have the management skill needed to grow the firm, they don’t have the drive. This is a firm I would rather buy, than invest in.
Alan Roberts