Plane-Parts Maker Doesn't Pass Our Inspection

Hollywood, Fla.-based Heico (HEI) specializes in getting its hands on PMAs by snapping up companies that already have them and by patiently submitting its own applications. It holds approvals for 6,000 parts today, of which 4,000 are actively marketed. Last year it added about 400 approvals.

Heico's parts often cost 40% less than those made by original engine makers. The airline business, with its high capital costs, volatile fuel prices, lack of ticket pricing power and expensive unions is a perfect recipe for financial difficulty, making parts discounts especially tempting. Some airlines sign with engine makers for long-term parts and service contracts, but they can do that with Heico, too, thanks to the company's longtime relationship with, and part ownership by, Lufthansa, the world leader in engine overhauls.

Over the past three years Heico's sales have increased by an average of 30% a year, more than three times the growth of the S&P 500 index's median company. That's not to say the company is taking over the business. It figures it captures less than 2% of parts sales. Last year sales totaled just $508 million. Also, it's growing at a healthy pace, but not like it used to. This year sales are expected to increase 14%. But the company generates enviable profits on its sales. Its operating margin, at 17.4%, is four to five percentage points better than those of GE and United Technologies.

Profits are growing faster than sales. This year they're expected to climb 21%. The stock price is growing faster still. I recommended Heico shares in July. They're up 26%, vs. a 9% dip for the S&P 500 index.

There's much for investors to like about Heico, but I have gripes.

The company has two classes of common stock, which despite the best arguments of managers, is almost never justified. The purpose is usually to allow a company to participate in the capital markets when it comes to raising money but to avoid it when it comes to being the target of a takeover — not great for stockholders. It also makes investors' research a bit trickier. In addition to figuring out whether the regular shares are a good deal relative to the broad market, they must determine whether the 29% premium to the Class A stock is justified. (Based on the historic spread, perhaps not.) Heico's dividend is too puny, considering the size of its free cash flow and the slowdown in its growth. In recent years it has shown no appetite for repurchasing its shares, and so the count has crept higher as options have been converted to stock.

That might be nitpicking, but with the stock now trading at 28 times forecast earnings for fiscal 2008 (ending Oct. 31), and the broad market looking cheap, I'm feeling choosey. Readers who bought shares in July should consider taking profits here.

For some ideas on what to buy, have a look at seven other companies that, along with Heico, recently turned up on a stock screen for small, fast growers. To run the search for yourself anytime, use the full list of search criteria and SmartMoney's stock screener.