ESE - ESCO Technologies: Trading At A Conglomerate Premium

2023-06-13 13:17:37 ET

Summary

• ESCO Technologies Inc. has a great long-term share price performance.
• The conglomerate has done all right and has been awarded a high valuation subsequently.
• I like the business, but simply feel that ESCO Technologies' valuation is a bit too demanding here to get involved.

Early in 2021, I concluded that the solid performance of shares of ESCO Technologies Inc. ( ESE ) came at a price. The diversified industrial conglomerate has proven to be a solid long-term value creator, while maintaining a pristine balance sheet , yet a 30 times earnings multiple at the time felt a bit too rich to me at the time.

Forwarding in time, we have seen modest operational advancements amidst a flattish share price, but the resulting share price valuation remains a bit too demanding for me here.

A Recap

ESCO is a spinoff from Emerson Electric Co. (EMR) in a transaction which goes back to the 1990s. The company was three-quarters of a billion business back in 2018, with activities tied to filtration, utility and test solutions, technical packaging and other small activities. A mere $3 share in the 1990s has risen to the $50 mark in 2005, followed by years of relative stagnation, as shares had risen to $95 early in 2021.

If we look at the business early in 2021, we have seen a business, which ended up posting 2020 earnings at $2.76 per share, with the results hurt a bit by the pandemic, as the balance sheet was debt free. For 2021, the company was set to post earnings above $3 per share amidst an unleveraged balance sheet which looked reasonable, but the long-term track record of the business seemed fully priced in.

Share Price Stagnation

Forwarding between February 2021 and today, we have seen shares not move at all on a net basis, with shares now trading at $97. That statement should not be confused by the observation that investors have not seen any volatility, as shares fell to the $60 mark in spring 2022, although they have made up the lost ground by now.

Following a few smaller bolt-on deals during 2021, the company posted its fiscal year results late in the year. Full year sales were actually down 2% to $715 million as earnings were lagging. Reported GAAP earnings came in at $2.42 per share, with adjusted earnings down eight cents to $2.59 per share. With the company racketing up a bit of debt following the bolt-on dealmaking efforts, the company guided for rather strong growth in 2022, with sales seen up to $810-$830 million, and adjusted earnings seen up to a midpoint of $3.20 per share.

In the end, the company has seen strong growth in 2022 with sales up to $858 million, far ahead of the original guidance. That was promising, although that adjusted earnings of $3.21 per share was exactly in line with the original guidance. The company guided for further increases in 2023 sales to $910-$930 million, with adjusted earnings seen between $3.45 and $3.60 per share.

The company produced a solid first quarter earnings report, when the company announced a bolt-on deal at the time as well, as the second quarter performance was good. On the back of these results, the company hiked the midpoint of the sales guidance by twenty million to $940 million, with adjusted earnings now seen at a midpoint of $3.60 per share. The company saw net debt increase to $113 million, although it still comes in at less than 1 times EBITDA. This is the result of some share buybacks and some smaller bolt-on deals, set to drive the business further.

And Now?

With nearly 26 million shares trading at $97, the market value of ESCO Technologies Inc. comes in around $2.5 billion, or $2.6 billion if we factor in net debt. The reality is that over the past two years shares have traded dead flat, and while the company has seen earnings increase a bit to $3.50 per share, (or even a bit higher), multiples remain demanding. After all, based on the revised and latest guidance, shares still trade at 27-28 times earnings, a demanding multiple even as the recent growth looks quite strong.

The ESCO Technologies Inc. multiple looks quite demanding, even if the aerospace business has become the largest segment of the business, complemented by the utility and test business. With some leverage taken on, I quite frankly believe that current multiples remain too demanding to get involved here. This makes me a patient investor, with hopes for a significant setback to the $70s before potentially contemplating a position here in ESCO Technologies Inc.

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