Esco Technologies (ESE) appears as of this writing in the Chaikin Analytics Bullish Swing Trade screen, which seeks stocks with Bullish Power Gauge ratings, generally favorable chart characteristics, and, we believe, a temporarily “oversold” condition.
Figure 7 illustrates key aspects of the company’s recent growth.
From Company July 2019 Presentation
Much of this occurred due to the company being, what we might call, a serial acquirer. That’s not stated in a negative light. In fact, Esco truly embraces its conglomerate status. Often, conglomerate status is something to be wary of, where risks include the possibility of overpaying for acquisitions, poor integration of newly acquired businesses, and/or loss of operational focus. Here, Figure 8 allays our concerns by showing that corporate returns are not deteriorating.
Data Courtesy of S&P Global with ratios calculated by Portfolio123
The most visible symptom of a flawed serial acquirer would be deteriorating corporate returns. Here, however, we see evidence that the acquisitions have been careful, calculated, and, as management claims, generally complementary to the current business profile. Historical acquisition behavior is consistent with notions of effective selection in picking companies to acquire and good judgment in the use of corporate cash flow.
What Does Esco Technologies Do?
Esco Technologies is a very diversified global provider of highly engineered products and solutions. It operates in the space, aerospace, healthcare, utilities, and consumer electronics industries. The subsidiary companies can be broken down into four segments.
From Company July 2019 Presentation
The Filtration and Fluid Flow group designs solutions to control fluid flow for machines used in the space, aerospace and defense industries. Containing 6 subsidiaries, this is the largest segment of the company, responsible for 37% of FY’18 Revenue, 83% of which was recurring revenue. The largest portion of this revenue was due to contracts relating to airplane manufacturing (approximately 50%). There’s also a significant revenue stream (~20%) coming from Navy contracts. Overall, this seems likely to be a reasonably business.
The second largest segment is Utility Solutions, which focuses on electric power infrastructure and optimizing its performance. With three subsidiary companies, Utility Solutions generated 28% of FY ’18 Revenue, 30% of which was recurring. By offering a full range of testing, monitoring, and problem-solving products, this segment shows the greatest potential to grow in the future, given the major challenge of aging infrastructure in the US.
Meanwhile, 24% of overall revenue came from Radio Frequency Shielding and Testing, with only 12% of that recurring. With migration from 4G to 5G on the horizon, it seems that this overall business still has plenty of growth opportunities ahead. Finally, Technical Packaging, contributed 11% of revenue, 80% of which was recurring.
Summing Up Esco Technologies
It appears that Esco Technologies is pursuing a strategy that is based on increasing the vertical and horizontal integration, while hedging its bets with government military contracts. The company exhibits stable income, considering that half of all sales are recurring revenue. This is a good sign for financial health and shows potential for the company to expand M&A activity. 40% of the company’s products are categorized as proprietary, which helps imply elements of a business moat.
Esco Technologies has generated solid increases in cash flow from operations that management intends to use to reduce debt and/or hold for future acquisitions. The company’s recent (7/9/19) acquisition of Globe Composite Solutions, a Navy Submarine supplier, is in line with this.
As noted particularly on the most recent earnings call, management truly embraces Esco Technologies’ conglomerate status, and looks to be showing potential to succeed at maintaining this status. The data from Figure 2 allows us to assume acquisitions are well planned, prepared, and executed. As is typically the case with most businesses, especially conglomerate, not all oars will be in the water at the same time. In the second quarter, for example, timing issues hit units in Alternative Energy (part of Utility Solutions) and Technical Packaging. Management, however, looks for a stronger second half in 2019.
Stock valuation ratios are high for Esco Technologies, and this is reflected in low scores in the relevant Power Gauge factors, but raw valuation ratios are never the whole story. Whether any ratio is too high, too low, or just right, is reflected in its relationship to growth expectations and business quality. Numerous other Power Gauge factors, particularly in the Technicals category, are consistent with Wall Street’s collective belief that the company’s quality and growth prospects are more than ample to justify the valuation.