EACO: A Case of an Extremely Low Float

Overview

Eaco Corp. (OOTC:EACO) is a very simple to understand company and this is a very simple investment thesis. EACO runs its business through a wholly owned subsidiary, Bisco Industries. Bisco is a distributor of electronics components and fasteners which are used in various industries such as aerospace, circuit board, communication, computer, fabrication, instrumentation, industrial equipment and marine industries.

In the microcap space, companies under $30 mil market cap do not need a reason to be undervalued as there are simply not that many people looking at these companies; however, in the case of EACO, there is a very clear reason: it has a float of 81.53k despite having 4.86 mil shares outstanding. So how did EACO get itself in a situation where the CEO, Glen F. Ceiley, owns 98.42% of the company’s stock? To understand how that happened, we need to go back to 2005. On June 2005, EACOs business of operating restaurants was failing, so it divested its restaurant operations. From 2005 to 2010, EACO’s operations consisted of managing five real estate properties. In 2010, EACO acquired Bisco Industries, or a more proper way to describe the situation would be that Bisco went public through a reverse merger.

“In connection with the Acquisition, EACO issued an aggregate of 4,705,669 shares of its common stock (the “Merger Shares”) to the sole shareholder of Bisco, Glen Ceiley, in exchange for all of the outstanding capital stock of Bisco. Immediately after the Acquisition and the issuance to him of the Merger Shares, Mr. Ceiley owned 98.9% of the outstanding common stock of EACO. Mr. Ceiley also owns 36,000 shares of the Series A Cumulative Convertible Preferred Stock of EACO.”

As of 2013, the real estate segment accounts for less than 1% of revenue, so it is not reported as a separate segment. The company has been trying to sell its real estate holdings and has done so in 2013 and 2014, so the financial information I present will exclude the gains from sales of real estate holdings as well as rental revenue. The company has also used up its federal NOL so I adjusted the tax rate for the past five years to 35% to make the net income comparable.

Financial Performance

(Note: All monetary numbers are in millions)

While I cannot find much information on Glen Ceiley, I believe the performance of the company is representative of management competence. Revenue has grown at a CAGR of 10% for the past 4 years while net income has grown at 16%. Growth in sales primarily comes from opening new sales offices, of which EACO currently has 45.

Competition

Bisco is essentially selling commodity products. On the other hand, they are not dependent on any single supplier (Bisco currently stocks over 87,000 items from more than 260 manufacturers) nor are they dependent on any large customers (more than 6000 active customers). This is not to say that Bisco doesn’t have any competitive advantage as economy of scale is a very important one. Being able to carry so many items allows them to be a one stop shop for many of their customers. I found a list that compiled the largest distributor of fasteners and Bisco is among them.

• Anixter International, Glenview, IL, $450 million (North America, OEM Supply, incl. fasteners)
• Barnes Distribution, Bristol, PA, $492.9 million
• BE Aerospace, Wellington, FL, $944 million (fasteners)
• Bisco Industries, Anaheim, CA, N/A
• Bossard America, $134.7 million
• Copper State Nut & Bolt, Phoenix, AZ, N/A
• EFC International, St. Louis, MO, N/A
• Endries International (Wolseley Industrial Group Company), $200 million
• Fastenal, Winona, MN, $1.3 billion (fasteners)
• Grainger, Chicago, IL, $8.1 billion
• Kimball Midwest, Columbus, OH, N/A
• Lawson Products, Chicago, IL, $315 million
• McMaster Carr, Chicago, IL, N/A
• MSC Industrial Supply, Melville, NY, $2 billion
• The Hillman Group, Chicago, IL, $279.6 million (fasteners)
• Wesco Distribution, Pittsburgh, PA, $2.1 billion (general & industrial supplies including fasteners)
• Wurth - North America, Ramsey, NJ, $1.1 billion

This is from 2012, but I suspect most of the names will be the same if there were a 2015 list. Mr. Ceiley is close to retirement and I suspect he will want to sell his company to one of these guys when he finally retires.

Recent Performance and Valuation

In the first nine months of FY 15, revenue has grown at 6.5%, which is a bit lower than historical average, but that is mainly because they did not expand their sales force. In fact, the opposite happened. EPS for the nine month was 0.57 and that was with a 41% tax rate. According to the latest PR: “The Company’s productivity gain from operations contributed to the Company’s net sales growth for the quarter vs. the same quarter a year ago, while the sales team numbered 310, a decrease of 4% from the 323 employees on May 31, 2014. The Company’s sales force is divided into Sales Focus Teams (SFTs). The Company had 91 SFTs as of May 31st, 2015, a decrease of 6% from 97 SFTs on May 31st, 2014. The Company continues to gain market share through its local presence business model. The decrease in headcount is a short term adjustment, but management anticipates continued growth in both our headcount and SFTs in the future.”

While I don’t expect the company to grow at 10% forever, they should be able to grow at around 6.5% for the foreseeable future once they start hiring again.

I believe Benjamin Graham gave no growth companies a PE of 8, so for a slow growth company, a PE of 10 makes sense which would be 80% upside from today’s price. 

Risks

1. Bisco is very reliant on its sales personnel, and I would say the majority of its SG&A are salaries for their sales personnel. Because of this, the company doesn’t really have much upside operating leverage. If they want to grow, they will need to hire and SG&A will increase along with revenue, but if a recession hits, revenue will go down faster than EACO can close office and fire sales personnel. I also don’t think it is in their best interest to fire people, due to the fact that it takes about one year before their sales personal can sell at their full potential. Unless, the recession is really deep, I don’t think EACO will be able to cut costs faster than their decline in revenue. This is one risk factor to look out for.

2. Bisco is not recession resistant and this has a lot to do with the first point. While Bisco operates in a wide range of industries and while they each have their own cycles, none of them are recession resistant.

3. Proprietary trading. No I’m not kidding, but apparently Mr. Ceiley is using the company’s money to trade. According to the 10k, “Bisco has historically made investments in marketable domestic equity securities. Bisco’s investment strategy includes taking both long and short positions, as well as utilizing options to maximize return. This strategy can lead, and has led, to significant losses based on market conditions and trends. We may incur losses in future periods from such trading activities, which could materially and adversely affect our liquidity and financial condition.” This hasn’t been much of a problem as the gains and losses from trading has been very minimal for the last couple of years EXCEPT for 2010 where the loss from trading was 3 mil, which was more than the company’s operating income for the year. It looks like Mr. Ceiley has realized he is not a market wizard, but I can’t say for certain if a loss of that magnitude will repeat again.

4. Huge opportunity cost if the stock just doesn’t move for a long time.

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