ETCC is Executing

I first wrote up ETCC in early 2019 with the stock at $0.58, having fallen from a high around $2 a year prior.  When the company stopped filing in 2020 I held and waited.  In mid-2021, with the stock in the $0.30's, I bought more as the company released new orders and told investors they would be getting current with financials.  

With a market cap of $2m in Feb 2023 the company announced an $85m contract.  As the stock spiked 4x up to $2 I sold nothing, thinking if that contract actually follows through it's going higher.  

As the stock fell back below $0.50 I bought more.  Fast forward to now and we have the stock at $1.78 with a $17m market cap.  Backlog is $109m.  The company has earned $0.09, $0.08, $0.17 the past three quarters, totalling $5.5m. 

If you've ever wondered how Buffett found a stock at PE = 3 here it is.

Of course there are negatives.  Book value is only $3.4m due to too much debt of $41m.  The preferred shares are an overhang as they accrue $485k per year in dividends totalling $5.7m now.  The 12,127 pref shares have a stated value of $1k each so it'd cost $12.1m+5.7m=$18.4m to buy them out.  They are convertible to 6.1m shares common at $1.98 each.  Probably the biggest risk is the recent good numbers being only temporary.  The stock was at a quarter before that big contract announcement after all.  

You can see the story in the chart.  

I thought for sure once the contract came and earnings fell to the bottom line we'd be at $5.  Over $3 at least.  Yet here we sit at the same level for three quarterly reports now.  Maybe the negatives are stronger than I thought.  

The biggest risk to me is the future.  Will the good times continue or do we drop back to a quarter.  To judge that we can look at order flow.  Below is a chart of backlog over the past few years and the main takeaway for me is the backlog staying up.  It didn't spike and drop but has grown even if you take out the $85m.  

Order flow has been pretty good recently:

• June 2023: ETC Awarded $17.3 Million Contract for its Sterilization Systems Group
• Jan 2024: ETC’s Aerospace Segment Awarded $12.4 Million in Contracts
• May 2024: ETC’s Commercial/Industrial Units Awarded Three Contracts Totaling $15.9 Million
• Sept 2024: ETC’s Aerospace and Commercial/Industrial Units Awarded Contracts Totaling $13.4 Million

Let's add revenue to the picture.  It's a pretty linear ramp which I suppose makes sense as they scale.  But backlog has increased by a larger percentage than revenue which makes me wonder if we still have growth ahead.  

Here's a quote from the most recent 10Q filed a few weeks ago.

"our ending sales backlog was $109 million. We expect to recognize as revenue approximately 64% of the backlog over the next twelve (12) months and approximately 96% of the backlog over the next twenty-four (24) months"

So they are expecting 109*0.64/4 ~= $17.4m avg revenue per quarter over the next 4 Qs.  What sort of earnings you think might come from that?  Earnings and revenue drive stocks after all.  Below is the past 4 quarters and take a look at that Q4.  Margins are always a question and I don't know how to judge that, but if we get a year like that then we have a 2-3 forward PE stock growing like a weed.  

Next big negative is that preferred.  I really wish it didn't exist but what can you do.  It wouldn't be interesting if all was bright and shiny.  The estate of H.F. Lenfest owns all the preferred and 23.5% of the common.  In my first ETCC blog post I postulated the company was going to get sold or have some event since he had passed.  He was with the company for decades and if he converted the pref he'd have 54% of ETCC.  His estate holds all the shares and I don't know their wishes but it wouldn't surprise me if an event were announced one of these days.  

Three options exist with the preferred.  

• It could be they are held forever to receive their 4% div at $485k per year.  So far those dividends have just been accruing and accruing, unpaid and sitting on the balance sheet.  Which again makes me wonder if the Lenfest estate is looking for an event to just take them out.  
• The preferred could be converted to 6.1m shares common at $1.98.  This would dilute us by 65% which I don't love but the company would receive $12m so maybe not the worst outcome.  They could pay off the accrued dividends and pocket $6m.   
• Or the company could buy out the preferred.  Personally I think this is most likely and it'll happen if and when there is ever an event and the company gets acquired or whatever happens.  As I noted above already it'd cost $18.4m to buy them out.   The company does have a history of buying back the preferred from Lenfest as you can see here in 2012.  That's when Lenfest was a director and their long time CEO William Mitchell was running the show (both are since gone).

Adding up the pros and cons I am surprised the stock isn't higher.  Getting to a valuation is always a guessing game but I'll give it a shot.  The multiple is dependent on the future and growth and who knows what will happen.  If we say it's worth 1x TTM revenue that's $54m.  10x TTM earnings would be $61m.  Subtract out $18.4m to buy the preferred and we get common stock worth $35.6m-$42.6 = $3.77-$4.51 per share.  

If we use the forward 12mo numbers based on backlog it looks even better.  That would be ~$70m revenue based on the company comments I noted above.  And if we think earnings scale as they did in the recent Q4 shown above we would have net income of $10m or more.  Again using 1x rev or 10x earnings we get a company value $70m-100m which translates to $5.5-$8.6 per share after buying out the preferred.  

I don't know what the stock is really worth but based on the past year and projections for the next year it can't be $1.78.  Besides the value I always think about the public perception and what we have in front of us is two good years based on backlog.  What happens if we get an earnings surprise or big order in this elevated state?  The higher the starting level, the better a big spike is. 

Maybe I'm too optimistic but that keeps me in long term and long term is where you capture the big money.  I'm always looking for the big money.  

So then why is the stock still at $1.78?  I always try to figure out why the market is giving me this gift.  

Here is where we have the final interesting tidbit on ETCC.  The most recent 10Q is missing Peter Kamin's name from the 5% shareholder list.  He held 1.1m shares in the quarter prior and for about a decade in fact he has just held and waited.  For him to have sold his way off that list he would've had to sell >=635k shares in June, July, Aug 2024.  If he was selling that much I imagine he'd sell all the way to nothing and he would be the main source of selling since the stock jumped over a dollar. 

I will leave his reasons for you to judge.  He's held for a long time at a loss and is worth so much this is a small position.  I think he's just taking the opportunity to move on. 

If Kamin has been selling at that rate he should be nearly done.  What happens when he's out? 

--Dan

disclosure: long ETCC

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