ESCO Technologies Looks to Ride Growth in its Aerospace and Defence and Utility Segments

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Written By Marcus Reynolds

ESCO Technologies provides filtration, fluid control products, and integrated propulsion systems for the aviation, navy, space, and industrial markets. It also specializes in radio frequency [RF] shielding, electromagnetic compatibility [EMC] test products, and diagnostic tools for the electric utilities and renewable energy markets.

ESE’s past financial results have demonstrated robust top-line growth. Additionally, profitability margins have been consistently expanding. In 2Q24, it continues to report revenue growth driven by its Aerospace and Defense and Utility Solutions Group segments.

Looking ahead, the recovery in aerospace and positive aircraft delivery outlook is anticipated to bolster ESE’s growth outlook. Additionally, the increase in global electricity consumption is also expected to support ESE’s growth. Given ESE’s positive outlook, the company is well-positioned for future growth.

Historical Financial Analysis

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ESE’s financial results have demonstrated robust top-line growth over the past few years. In 2021, it reported total net sales of approximately $715.40 million. In 2022, net sales grew 19.9% year-over-year to $857.5 million, driven by all three segments: Aerospace and Defense [A&D], Utility Solutions Group [USG], and RF Test & Measurement [Test].

The A&D segment’s net sales increased 11.6%, driven by an increase in commercial aerospace sales as a result of the COVID-19 pandemic’s recovery. The USG segment increased 37.2%, driven primarily by the acquisitions of Altanova and Phenix and increased sales from Doble and NRG.

Lastly, the Test segment was up 15.2% year-over-year, driven by increased demand for medical and industrial shielding and power filters.

In 2023, net sales increased 11.5% year-over-year to $956.0 million. This growth was driven primarily by its USG and A&D segments, partially offset by weakness in the Test segment. Additionally, the acquisition of CMT contributed approximately $10 million in net sales.

The A&D segment increased 11.7% year-over-year, attributed to the recovery from the COVID-19 pandemic. The USG segment was up 23.0%, driven by increased shipments of condition monitoring and protection testing products and higher NRG net sales due to increased shipments of wind energy assessment towers and sensors and solar products. The Test segment was down 2.8%, mainly due to COVID-19 disruptions in China.

Regarding profitability margins, both EBIT margin and net earnings margin have been consistently expanding over the last three years. In 2023, A&D’s EBIT increased 4.7% due to higher volumes. USG’s EBIT increased 33.2% year-over-year, driven by increased volume in Doble and NRG.

The Test segment’s EBIT declined by 0.6% due to COVID disruptions in China. On a consolidated basis, the 2023 EBIT margin expanded from 13% to 13.40%. Additionally, the net earnings margin increased from 9.60% to 9.68%.

Second Quarter 2024 Earnings Analysis

For 2Q24, ESE’s sales grew 8.7% year-over-year to $249.1 million, driven by its Aerospace and Defense and Utility Solutions Group segments. The A&D segment’s net sales increased 15.9% year-over-year to $114.7 million, attributed to an increase in commercial aerospace and defense aerospace shipments and Navy revenue.

The USG segment’s net sales increased 10.2% year-over-year to $87.3 million, driven primarily by an increase in service revenue, cybersecurity and compliance revenue, and NRG’s net sales.

However, the Test segment net sales fell $3.9 million, or 7.6% year-over-year, to $47.1 million due to lower wireless, filters, and acoustic volumes, which negatively impacted its US and European operations. The Test segment’s Asian operations partially offset the decline.

On a consolidated basis, ESE’s EBIT margin expanded from 11.18% to 13.03%. The A&D segment’s EBIT margin increased from 19% to 20.4%, driven by leverage on higher volumes and increased pricing. USG’s EBIT margin expanded from 17.8% to 20.2%, driven by leverage on higher volumes and pricing increases.

The Test segment’s EBIT margin fell from 14.2% to 11.7%, driven by lower sales volumes in its US and European operations.

As a result of EBIT margin expansion, ESE’s 2Q24 net earnings margin expanded from 7.80% to 9.32%. EPS increased from $0.69 to $0.90, a year-over-year increase of 30.4%. For the quarter, ESE’s entered orders fell 5% to $239.1 million due to aerospace strength being offset by weak test orders. The 2Q24 book-to-bill ratio is 0.96, while its backlog increased 8% year-over-year.

Recovery in Aerospace

ESE’s A&D segment offers highly engineered products and services to the industrial, aerospace, navy, and space sectors. According to Accenture, it is forecast that in 2024, global commercial aerospace revenue will surpass 2019 levels. For 2024, global commercial aerospace revenue is forecast to grow approximately 11% year-over-year, driven by airlines’ need for more efficient aircraft, supply chain improvements, and increasing demand for maintenance, repair, and overhaul [MRO].

Aircraft delivery is also expected to increase, with Boeing and Airbus combined forecast to deliver approximately 1,400 aircraft in 2024.

The total number of aircraft is expected to reach approximately 46,560 by 2042, with the demand for new passenger and freighter aircraft around 40,850. This positive outlook for the aerospace industry is expected to bolster ESE’s growth.

Increasing Power Consumption

Global electricity consumption is anticipated to increase from now to 2050. By 2050, global electricity consumption is forecast to more than double from the current level of approximately 25,000 terawatt-hours [TWh] to between 52,000 and 71,000 TWh. The main driver behind the increase is the electrification of economies and the growing energy needs of emerging economies.

China’s power demand is forecast to reach approximately 16.8 TWh, North and Central America’s demand around 10.5 TWh, and India’s approximately 6.9 TWh. Combined, these three regions’ power demand in 2050 will account for over half of the global power demand. The forecasted growth in global power demand is expected to bolster ESE’s outlook.

Relative Valuation Model

Based on ESE’s most recent 2023 10K, the company lists its competitors. ESE’s forward revenue growth rate is 8.59%, slightly outperforming its peers’ median of 8.12%. However, in terms of profitability margins TTM, ESE slightly underperformed. ESE’s EBITDA margin TTM is 19.35%, below the peers’ median of 20.52%. The net income margin TTM is 9.94% vs. peers’ median of 11.25%.

Currently, ESE’s forward non-GAAP P/E ratio is 24.26x, slightly below the peers’ median of 25.21x. Given ESE’s underperformance against its peers in terms of margins, it is fair for ESE to trade below its peers’ median P/E.

Risks and Conclusion

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ESE’s dependence on sales to the US government poses a risk. These sales, mainly in its A&D segment, have accounted for about 26% of total revenues over the last three fiscal years and are reliant on government funding, which may be negatively impacted by prolonged government shutdowns and the inability to obtain timely and sufficient appropriations.

Over the last three years, ESE has shown strong top-line growth and expanded profit margins. The favorable outlook for the aerospace industry and the forecasted growth in global power demand are expected to bolster ESE’s growth. Given these positive trends, ESE is well-positioned for future growth.

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