Espey Manufacturing: Defensive Play, Unknown Catalyst

I generally bucket my ideas into two categories.

The first bucket consist of buy and hold forever types – the usual elements involve high returns on invested capital, high inside ownership and management alignment, as well as industry beating margins. My only holding thus far in this bucket (though it’s a large one) is Berkshire Hathaway B shares. I’ve outlined why in the previous article.

The second bucket consists of more speculative holdings. These are typically companies with:

  • high levels of recent insider purchases comparative to salary/remuneration
  • trading at attractive valuations
  • have a high chance of positive catalyst
  • generally risk/reward asymmetric

There are occasionally festive seasons where companies fall into both the first and second buckets, possessed of both excellent businesses and insider purchases as well as an attractive valuation (Berkshire buying its own shares back at $170 as an example) – but these are far and few between and I often find them too late.

Alas.

Today’s topic: the 2nd bucket.

Espey Manufacturing & Electronics Corp’s (Ticker: ESP)

Insiders recently bought a ton of stock.

mkt cap: 50m
enterprise value: 38m
No debt
11m in cash and cash equivalents
5% yield consisting of $0.25 every quarter.

Historical profitability:

A little digging on their website also showed 2 more pertinent factors, the first, increased hiring momentum (https://www.espey.com/about-espey/careers/) and the 2nd, the sticky nature of their business.

A run down of the business summary in general:

Espey Mfg. & Electronics Corp., a power electronics design and original equipment manufacturing company, designs, manufactures, and tests electronic equipment primarily for use in military and industrial applications in the United States and internationally. Its principal products include power supplies, power converters, filters, power transformers, magnetic components, power distribution equipment, UPS systems, antennas, and high power radar systems for use in AC and DC locomotives, shipboard power, shipboard radar, airborne power, ground-based radar, and ground mobile power applications. The company also provides various services that consist of design and development to specification, build to print, design services, design studies, environmental testing services, metal fabrication, painting services, and development of automatic testing equipment. It serves industrial manufacturers and defense companies, the government of the United States, foreign governments, and foreign electronic equipment companies through its direct sales organization and outside sales representatives. Espey Mfg. & Electronics Corp. was founded in 1928 and is based in Saratoga Springs, New York.”

Some of the platforms they serve:

Airborne platforms:

  • Raytheon J-LENS counter-cruise missile aerostat
  • Apache AH-64 vision and targeting system
  • F-16 and F-18 helmet visor targeting display
  • E2- C Hawkeye and E2-D Advanced Hawkeye high voltage power supplies
  • C-130 Hercules transformers.

Ground platforms:

  • Lockheed-Martin TPS-79 MMSR Radar
  • Raytheon Patriot Missile
  • BMD and THAAD radar system
  • Lantirn ER targeting pod
  • NATO Early Warning Radar full rack transmitter (build-to-print)

Naval platforms:

  • Zumwalt Class (DDG-1000) destroyers
  • Littoral Combat Ship (LCS-1)
  • Virginia, Seawolf, and Ohio class submarines
  • ALFS (AN/AQS-22) dipping sonar
  • Oliver Perry Class (FFG-7)
  • Arleigh Burke Class (DDG-51) Destroyers
  • Several frigates and patrol class ships in foreign allies

In short, they manufacture mission critical component parts for weapon platforms as well as ruggedized industrial vehicles.

When you build a $1.84 billion dollar destroyer or other similar billion dollar platforms, you don’t randomly just ignore the mission critical component parts.

You buy them, maintain them, and ideally go back to the same guy who manufactured them to keep them updated and running. That’s a recipe for a highly sticky business that keeps recurring for as long as defense spending goes on: which in the USA, probably does for a very long time to come.

That probably explains why revenues hasn’t dipped too much in reflection of cyclicality.

Also, take a look at US slated defense spending.

Take from that what you will.

Moving on.

Risks: Ongoing Shareholder Dilution

Share count has increased. I’m not certain why they keep doing this (beyond the usual insider enrichment at the general shareholder’s expense) and it’s making me wary. There’s also the hangover of a possible union action somewhere hidden in this if things get worse.

Having said that, the company does pay a decent yield, has a very sticky business, is unlikely to be endangered anytime soon due to a lack of debt, and going by its job posting, likely has several large contracts due to be announced soon or just an increase in business backlog.

Conclusion

The company has no debt, pays out 5% in yields, and has a sticky defensive (literal and metaphorical) business. There’s a decent chance insiders know something you don’t and I think they either won a big contract or have received bigger order numbers somewhere. Sooner or later, we’ll know.

Disclosure: Long.

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