As a producer of aircraft landing gear, the Quebec-based company is heavily exposed to the resumption of commercial air travel. You wouldn’t know that by looking at how the company is valued.
Even compared with its closest U.S. peers, Héroux-Devtek trades at an enormous discount. “I don’t know if it’s because it’s a smaller-cap Canadian name, but it just gets overlooked,” said James Telfser, a portfolio manager at Aventine Investment Counsel.
“There’s huge upside here with airlines getting back to business,” Mr. Telfser said. “Now is the time to pounce on the stock.”
Aerospace and defence stocks caught an updraft around the same time blockbuster COVID-19 vaccine news first made headlines last November. Within a couple of months, the SPDR S&P Aerospace & Defense ETF, for example, was back to its pre-pandemic high.
While Héroux-Devtek shares have also surged higher over that time, at $17.29 on the TSX they still trade 20 per cent below their February, 2020, high. The stock currently trades at roughly 8.1 times forward EBITDA estimates, while the average for a group of comparable U.S. stocks is 14.3 times. This is an “unjustified valuation disconnect versus U.S. peers,” Desjardins Securities’ analyst Benoit Poirier said in a note. Especially considering Héroux-Devtek managed to sidestep the worst of the airline industry’s meltdown.
When the pandemic grounded most of the world’s fleet of passenger jets, aircraft manufacturers slashed production. This, of course, meant trouble for the multitude of companies that supply parts to the OEMs.
Héroux-Devtek, which makes landing gear systems for industry giants Airbus SE and Boeing Co., saw its stock lose nearly 60 per cent of its value in less than two months.
To help offset the precipitous decline on the commercial side, the company bolstered its defence segment.
“They’ve done a really good job of shifting to the defence side, when they needed to,” Mr. Telfser said. “Their reputation is starting to get out there more and they’re winning new contracts.”
New landing gear programs were accelerated, such as for Boeing’s F/A-18 Super Hornet built for the U.S. Navy, while existing platforms, such as Lockheed Martin’s F-35 Lightning II fighter jet, were expanded.
In the quarter ended March 31, Héroux-Devtek realized a 13-per-cent year-over-year increase in defence revenue, helping to dull the blow of a 34-per-cent decline in commercial revenue, according to financial results released last week. As a result, the company exceeded estimates for adjusted earnings per share by more than 20 per cent – its 10th consecutive quarterly beat.
It could have been much worse. In what was an incredibly difficult year, the company’s total sales declined by just 7 per cent over the prior year, while free cash flow more than doubled, which, in turn, was used to reduce debt.
“Despite the significant disruption caused by the pandemic, management continues to position the business to thrive on the other side of the crisis,” Mr. Poirier said.
The other side is still a ways off, however.
People are starting to get on planes again, particularly in the U.S., as the COVID-19 vaccination program has rolled out. In April, daily bookings for domestic U.S. travel were back up to 74 per cent of precrisis levels. International bookings, on the other hand, were still just one-fifth of normal levels.
“Though early signs of a recovery are materializing, we do not expect a return to pre-pandemic levels for several years,” Raymond James analyst Bryan Fast wrote in a recent note.
“In the meantime, Héroux can lean on their increasingly important and steady defense segment,” Mr. Fast said.
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