Espey Manufacturing & Electronics: Small and Undervalued

I have been and owner of shares in Espey Manufacturing & Electronics Corp. (ESP) for the last couple of years and have also added this company to accounts I manage with my firm, Freedom Mountain Investments. Espey is the type of micro-cap that receives almost no analyst or media coverage. It is the type of small determined company that can produce excellent investment results for the nimble individual investor. I would recommend limit orders only given the thin trading on most days.

Espey is in the business of desigining, development and manufacture of electronic power supplies, transformers and other types of iron-core components, and electronic system components in the United States. Its electronic power supplies and components are primarily used in shipboard and land-based radar, locomotives, aircraft, communication systems, navigation systems, and land-based military vehicles.

ESP reported quarterly earnings this week. Sales and earnings were up nicely. ESP continues to have a significant order backlog - giving pretty good insurance of future finanical results. A likely new $6MM order would increase this backlog:

The Company has received a preliminary agreement to commence performance on a contract for military power supplies expected to be in the approximate amount of $6 million. A definitive agreement is expected by April 30, 2008. Excluding the above preliminary contract, the Company's backlog is $34.5 million at February 12, 2008.

ESP has a very strong balance sheet with over $15 MM of cash and short term investments with no long term debt. This is for a company with a market cap of just $43.5 MM. Currently ESP sells at a multiple of 1.5 times net working capital. The p/e on a trailing basis is about 15, price to book about 1.4. The net profit margin has grown nicely in recent years and exceeds 9% for 2007.

One risk factor with ESP is very significant concentration of orders with a few key customers. Many of the products are used by the US military. From their most recent 10-Q filing:

Sales to two significant customers in the first half of fiscal 2008 represented 57.7%, while sales to three significant customers in the first half of fiscal 2007 represented 69.0%, respectively, of the Company's total sales. While the Company has always had a small number of customers that account for a large percentage of its total sales in any given year, management is pursuing business opportunities involving significant product programs with new and current customers with an overall objective of lowering the concentration of sales and minimizing the impact of a significant customer or excessive reliance upon a single major product program of a particular customer. The current backlog at December 31, 2007 of $31.4 million includes $21.9 million from the two most significant customers in the first half of fiscal 2008.

Another possible risk factor would be a significant pullback in US military spending, but even with the upcoming election uncertainty that risk does not seem too high given the uncertain world geopolitical environment.

ESP has more than doubled earnings over the past 5 year period, with the stock price roughly doubling in that time period, even with the recent pullback. ESP pays a 3.7% dividend at the February 15 closing price of $18.75.

The Espey Employment Retirement Plan and Trust owns nearly 30% of the float. CEO Howard Pinsley owns 5.4%.

This type of micro cap contract manufacturer is out of fashion in today's market. I believe that even given the significant customer concentration risk, ESP is significantly undervalued at the current market price.

Disclosure: Author has a long position in ESP