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Espey Manufacturing & Electronics Corp (ESP) is a power electronics design and original equipment manufacturing company with a long history of developing and delivering products for use in military and severe environment applications. All design, manufacturing and testing is performed in its more than 150,000 square-foot facility located at Saratoga Springs, N.Y.
Valuation
ESP is currently trading at a trailing twelve months P/E of 12.70 and a trailing 12 months EV/EBITDA of 7.10. In terms of asset-based valuations, it is currently valued at 2.08x P/B, a 25% premium to its five-year average P/B of 1.66x. ESP achieved a 15.9% ROE for the past 12 months and a five-year average ROE of 12.3%.
Financial and Business Risks
ESP is debt free with cash and cash equivalents of $14.3 million representing 22% of its current market capitalization of $63.4 million.
ESP faces competition in all of its products, with competitors ranging from divisions of multi-national electronics manufacturers to single facility businesses. Furthermore, ESP's sales do not represent a significant portion of market share for any class of its products and it competes on price and product performance.
Sales to ESP's top two customers accounted for 37% and 23% of total sales in 2012, respectively.
According to ESP, certain components used in its products are available from only a limited number of sources, and other components are only available from a single source. ESP is comfortable with taking on supplier concentration risk, in exchange for benefits such as higher quality goods and timely delivery.
Business Quality and Capital Allocation
ESP maintains 20% to 25% of its annual sales to non-defense applications, as a hedge against defense spending cuts. ESP also believes that the impact of any cutbacks in military spending is partially mitigated by the fact that expensive platforms and personnel, which are more likely targets of budget cuts, are not core components of its business strategy. Moreover, an upgrade of a legacy system is typically regarded as more cost-effective than development of an entirely new system, which favors ESP. ESP's experience is that functionality and the electrical power requirement is generally increased in the upgrade of legacy systems, resulting in more demand for ESP’s products.
On June 21, 2012, ESP was recognized by the Defense Security Service with the 2012 James S. Cogswell
Outstanding Industrial Security Achievement Awards. This is the second Cogswell that ESP has received over the last seven years. The award is presented to a very elite group of companies comprised of only less than 1% of over 13,000 thousand cleared defense contractors.
ESP has been profitable for the past decade with operating margins consistently above 10% for the past six years. EPS growth remains strong, with a three-year EPS CAGR of 15% and a five-year EPS CAGR of 10%.
ESP has paid dividends in every single year since 1999, and currently sports a dividend yield of 3.7% with a dividend payout ratio of 44%. Dividends are paid quarterly. On Dec. 3, 2012, ESP announced that its board of directors has declared a special cash dividend of $1.00 per share. This special dividend is in addition to a regular quarterly dividend that has been increased from $0.225 to $0.25 of common stock per share.
Conclusion
ESP has paid a special dividend of at least $1.00 per share for each of the last five fiscal years 2008, 2009, 2010, 2011 and 2012. The special dividend should be treated as an ordinary dividend because of its recurring nature and the significant net cash balances. The readjusted dividend yield should be 7% instead, making the stock much more attractive.
Disclosure
The author does not have a position in any of the stocks mentioned.
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