HEI vs. HEI/A: Pair Opportunity?

HEI vs. HEI/A: Pair Opportunity?



HEI vs. HEI/A: Pair Opportunity? - hei2





Heico is an interesting, family dominated industrial with a dual class structure (Common and Class A).  Heico’s best business is the manufacture of FAA certified, slightly-lower-priced replacement parts for aircraft (Flight Support, ~57% of 2012 operating income).  By undercutting OEMs like GE and Pratt, HEI has built a high margin business with plenty of runway for growth.  Heico also has what could broadly be described as a successful aerospace/defense electronics business (Electronic Technologies, ~43% of 2012 operating income).


For the purposes if this discussion, what Heico does is not as important as the relative characteristics of the Class A (HEI/A) and Common (HEI) shares.  The spread between the two share classes appears abnormally wide at current levels, as shown in the chart above, having reached this level of divergence only a handful of times in the past dozen years.  Shorting the common and buying the Class A is worth considering, if it matches the reader's style,, even though it is not a position that could be all that large (HEI trades about 40k shares a day with 42.16 close yesterday).  Positions like long HEI/A vs. short HEI can be useful at extremes.  Reversals can be fairly quick once started, but timing the inflection is, of course, very challenging.  It is also noteworthy that HEI options have recently displayed elevated implied volatility, although we are not entirely certain as to why, and may be a point for further research.  




  • Key Differences:  The HEI Class A shares offer 1/10th of vote while the common HEI shares offer 1 full vote.  The common shares are more liquid, with about 3x more volume over the past few months.  Both classes of shares have been repurchase targets, with the HEI common shares more favored in 2011.
  • What a Full Vote Buys:  Heico insiders exert significant influence over the company, collectively holding about 6% of Class A shares and 21% of the common.  Three members of the Mendelson family sit on the Board of Directors and are in senior management.  While insider may not have a lock on corporate control, it appears to us that current management exerts significant control over the company.  Anti-takeover provisions may leave a would-be activist challenged to acquire meaningful influence.  For most shareholders, the extra votes do not appear to add much value.
  • Liquidity Better in HEI/A:  Better liquidity certainly matters, in so far as it persists.  The HEI common shares likely deserve a liquidity premium to the Class A shares, but the >40% magnitude appears abnormally large.
  • No Arbitrage: There is no mechanism that forces these two share classes to match, except in the case of a few specific events.  The Common premium could theoretically go anywhere. Historically, the current premium is at the high-end of the range - even relative to stressed equity markets.  That said, positions like these can be slow to work out and can diverge further.  The two securities are economically pretty close to identical, by our assessment, but do not have to trade that way.
  • Events That Could Collapse Premium:  Many companies have eliminated dual class structures, but that seems an unlikely short-run outcome at Heico.  A sale of the company or MLBO would also likely eliminate the premium.  The Chairman, CEO and elder Mendelson, Laurans, is 74, so the company may well be preparing for an eventual change at the top.
  • What Insiders Prefer:  Since January 2012, insiders have only made one small purchase of HEI common.  On balance, insiders have sold nearly 50,000 HEI common share. At the same time, there have been many HEI/A purchases (net addition of over 4,000 shares) with Victor, Eric and Laurans Mendelson choosing the Class A shares.  We assume that they know which share class offers the best value. 
  • Even For Longs:  A long-term investor interested in HEI should look at buying the Class A instead of the common at present levels.  Long-term holders also may benefit from a swap, liquidity permitting.



The fundamental outlook for Estée Lauder remains favorable versus its Personal Care peers. For a candidate to short against an EL long position, we would look no further than KMB.


Estée Lauder surprised the Street to the upside on 8/15 with 8% organic sales growth in 4QFY13 and strong operating leverage. Subdued guidance for FY14 was largely shrugged off by the market since, with the stock outperforming the S&P 500 and peer consumer staples stocks by 14 bps and 182 bps, respectively, since the earnings release. We believe that EL is likely to raise its conservative guidance as accelerating sales and margin growth drives shareholder returns. At 22x earnings, the stock is valued roughly at the mid-point of its historical range and in line with slower-growth, higher-yielding stocks like PG that are more susceptible to the downside of rates rising.


Kimberly Clark disappointed investors with its 7/22 earnings release as soft volumes in the U.S. and FX headwinds in emerging markets combined to disappoint investors. We believe the possibility of a guide-down increased since the last earnings release, with management stating that share repurchases and cost cutting measures would fill the void left by slower-than-expected revenue growth in FY13. As a result, the company reiterated its FY13 earnings growth guidance of 8%. In light of inflation costs accelerating, we believe a guide-down is likely in 2H13. See charts below for more details.



Revenue: EL, in our view, has the more favorable revenue growth outlook with management expecting 6-8% organic sales growth for FY14. Exposure to the high end consumer remains a strong point, with premium brands’ sales growing much more rapidly (~20%) than the overall portfolio (6%) in 4QFY13. Earnings across retail have continued to suggest a bifurcation among consumers that is leading the high end to outperform the mid- and low-tier concepts.


KMB is seeing weakness in developed markets like the U.S., Australia, and South Korea. U.S. Personal Care volumes declining despite negative product mix was a concern. For household product makers like KMB, growing volumes in the U.S. could remain challenging with disposable incomes in the U.S. stagnating. Emerging markets continued to be pressured by unfavorable currency rates of ~3%.



Margin Outlook: EL continues to drive margin expansion through its long-term strategies aimed at increasing efficiency in its business model. Over the past four years, sales have grown by 40% and operating margins have doubled. Management is confident that the FY16 operating margin target of 16.5% is achievable.


KMB faces several headwinds, with respect to its operating margin, in 2H13, as commodity inflation has been accelerating during 3Q to-date. We believe this heightens the likelihood of a guide-down from KMB during 2H13.


EL – A CUT ABOVE THE REST - kmb inflation chart1


EL – A CUT ABOVE THE REST - kmb cost savings



Quantitative View: Our macro team’s quantitative view of EL and KMB corroborates our fundamental view of the respective stocks. EL needs to hold above its intermediate-term TREND line of $66.68. KMB has broken its intermediate-term TREND line of $97.96.


EL – A CUT ABOVE THE REST - el levels 8.27


EL – A CUT ABOVE THE REST - kmb levels 8.27



Rory Green

Senior Analyst



Patience: SP500 Levels, Refreshed

Takeaway: It’s a range bound bullish TREND in SPY with immediate-term TRADE resistance, for now. Growth stocks still look great.



I didn’t play the 1st correction as well as I would have liked, but I’m happy with how we faded the bounce. Now I need to make decisions on not only buying this dip, but selling this rip (in Gold, Treasuries, etc.). There’s plenty to do out there today,


Across our core risk management durations in the SP500, here are the lines that matter to me most:


  1. Immediate-term TRADE resistance = 1670
  2. Immediate-term TRADE support = 1637
  3. Intermediate-term TREND support = 1631


In other words, its game time. The US stock market either holds here or it does not. Same thing with both Gold and Treasuries – they either fade at lower-highs (again), or they do not.


Have some patience – this isn’t the all-or-none market people want it to be. It’s a range bound bullish TREND in SPY with immediate-term TRADE resistance, for now. Growth stocks still look great.



Patience: SP500 Levels, Refreshed - SPX


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[VIDEO] FLASHBACK: JCPenney Wise, Pound Foolish


A little over two years ago, the market went bananas over news J.C. Penney hired Ron Johnson away from Apple to lead the struggling retailer as its new CEO. While consensus celebrated the announcement, sending the stock up almost 20%, Hedgeye Retail Sector Head Brian McGough didn’t budge on his bearish forecast for the company.


As this interview with CNBC’s Maria Bartiromo shows, McGough unequivocally told investors to get out of JC Penney and that Wall Street got it wrong. If Bill Ackman had listened, he could have saved himself about $500 million. 


Morning Reads on Our Radar Screen

Takeaway: A quick look at stories on Hedgeye's radar screen.

Keith McCullough – CEO

Ackman Folds (via Zero Hedge)

Emerging Stocks Fall Most in Eight Weeks (via Bloomberg)

Dubai Market Down 7% (via Bloomberg)

Japan's newest rocket fails to lift off (via Reuters)

India lower house of parliament passes cheap food plan (via BBC)


Morning Reads on Our Radar Screen - ack2


Brian McGough – Retail

His Links Severed, Ackman Sells Stake in J.C. Penney (via New York Times)

Billabong brand declared worthless as company posts huge loss (via CNNMoney)


Josh Steiner – Financials

Facebook friends could change your credit score (via CNNMoney)


Jonathan Casteleyn – Financials

America Resilient Five Years After Great Recession (via Bloomberg)

Bats Agrees to Merge With Direct Edge as Volume Shrinks (via Bloomberg)


Howard Penney – Restaurants

Cosi CEO Blames The Chain's Troubles On His Employees (via Business Insider)

McDonald's Japan appoints new leader as sales slump (via Reuters)


Client Talking Points


EEM is not the perfect ETF representing the Emerging Markets short call, but it’s the most widely held. And guess what? It's for sale right now, provided that we continue to see pressure on Emerging Market currencies. We do think we will continue to see #GrowthSlowing on a real-inflation adjusted basis in EM. Basically, we are as bearish on EM as we are bullish on US Growth (QQQ). Yes I know. It's weird, but it's working.


India is the poster child of currency crisis developing into a current account deficit problem (as overall growth slows and inflation accelerates). India’s Sensex was hit hard down -3.1% overnight. It's down -11.5% since mid July. That said, it actually outperformed Indonesia and the Philippines overnight which were smoked for big -3.9% and 4% losses, respectively. Don't forget: #AsianContagion is one of Hedgeye's top Q3 Macro Themes. It's working out well for us, not so much for them.


We don’t like everything US Equities. In fact, we definitely don’t like slow growth sectors like Utilities and Consumer Staples. Not at all. The number one thing that concerns me on growth stocks is Oil being so sticky up here. $108.11 is the long-term TAIL risk line for Brent, and SPY just failed at my immediate-term TRADE line of 1671 resistance. We are watching this relationship closely.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.


Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016.


Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward.  Near-term market mayhem should not hamper this  trend, even if it means slightly higher borrowing costs for hospitals down the road.

Three for the Road


COMMODITIES: Gold and Oil continue higher; rarely a good thing for Global Growth expecations @KeithMcCullough


"I'd rather roll the bones at Mohegan Sun than try to trade some of these 2013 commodity blowups." -Keith McCullough


Average 401(k) balances were up more than 10% in Q2. Fidelity Investment's average 401(k) balance came in at $80,600 at the end of the second quarter of 2013 -- up more than 10% from the same time last year, according to a report released Tuesday by Fidelity, which represents 12.4 million U.S. workers.

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