Update: ESCO Q2 Earnings - Revenue Misses But Earnings Beat, Sales And EPS Up Y/Y

| About: ESCO Technologies (ESE)


Revenues increased 12% Y/Y, primarily due to an acquisition. EPS improved significantly from $0.24 to $0.43.

The long thesis has been working well, with waiting for the dip paying off as the stock price otherwise just remained flat Y/Y.

I reiterate my long thesis but investors should again wait for a ~10% pullback to improve reward-risk. My target price is then $37, offering a ~9% upside.

ESCO Technologies, Inc. (NYSE:ESE) reported mixed Q2 2014 results (SEC filing, press release, earnings call). Adjusted EPS from continuing operations was $0.44, compared to $0.33 a year ago, beating the guidance of $0.36 to $0.41. GAAP EPS from continuing operations was $0.43, compared to $0.24 Y/Y. Sales increased $14M, or 12% to $130M. The Y/Y increase is primarily thanks to the acquisition of Canyon Engineering in June 2013. The filtration segment sales increased 7%, test sales jumped by 23% and utility solutions group sales were up 4% Y/Y. Gross margin fell from 40% to 39%. Net debt was practically extinguished due to the divestiture of Aclara business. Orders received in Q3 2014 were $150M and the book-to-bill ratio was 1.15x. Backlog increased 7%, at a significantly slower rate than the current 12% Y/Y sales growth.

For the nine months ended on June 30, 2014, ESCO has shown solid progress as sales, EBIT, EPS, cash flow and orders have all shown meaningful increases. The quarterly dividend remains the same, at $0.08, yielding below 1%. Management expects 2014 adjusted EPS from continuing operations to be at the high end of the previously communicated range of $1.50 to $1.60. Q3 adjusted EPS from continuing operations should be in the range of $0.44 to $0.48 per share.

My thesis that ESCO lacked focus and would just muddle through and not offer much upside turned out to be correct. My advice to "wait for the price to fall by at least 15-18%" turned out to work very well, as the stock fell ~15% in a matter of weeks. Using the $30.5 as a buy price, the trade returned ~20% at its peak, and returns ~11% now. However, without waiting for that pullback, the stock trade would have actually been flat to slightly down. So my thesis of mediocre performance was very correct. I reiterate this "muddle through" performance thesis. The stock will probably underperform the broad market, but if investors wait for a ~10% pullback, they can make a decent return on their investment. My target price is $37 per share within a year, offering a maximum 9% upside plus the 1% dividend yield. However, the stock is likely to oscillate below this target price most of the time as at the current valuation, the stock still prices in a high future EPS growth, which will be hard to achieve, although the recent improvements are promising. Still, the company is trading at 23.46 trailing P/E, 19.11 forward P/E, 1.77 P/S ratio and 29x P/FCF. This simply is not cheap enough for the growth it promises. Therefore, the stock will probably underperform the broad market.

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