IEH CORP IEHC
July 27, 2020 - 4:35pm EST by
BJG
2020 2021
Price: 17.25 EPS 0 0
Shares Out. (in M): 2 P/E 0 0
Market Cap (in $M): 41 P/FCF 0 0
Net Debt (in $M): -8 EBIT 0 0
TEV ($): 33 TEV/EBIT 0 0

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Description

IEH Corp (IEHC) has been written up once prior on VIC, in 2013.  Shares are up approx. 7x since that time. Over the same time frame, revenues are up a little more than 2x, EBIT up ~4x and Net Earnings up ~5x. At 12/31/19, the company's most recent financial filing, balance sheet cash stood at $8.2MM with $5.8MM in Receivables and $14MM in inventories versus $4.7MM in total liabilities. 2.36MM shares were outstanding as of February 2020. Ten years ago, the company had 2.303MM shares outstanding. The company's fiscal year ends 3/31 and plans to file its annual report and results before August 13.

Under aggressively discounted multiples versus Smiths Group - a lower margin, lower grower but much larger and more diversified business - IEH Corp shares are worth +70% relative to current $17 share price.

IEH is a nice business that with an aligned owner-operator at the helm, strong balance sheet ($8MM on a $40MM market cap), generates attractive ROEs, and has shown the ability to grow sales and into new markets with their connectors. 

  • Cheap, well capitalized, Growing, owner-operator business with attractive capital returns. ROE has averaged 17% over the past 10 years.
  • Low cost but critical component for end user products. The company puts itself out as a premium product, noting it doesn't compete on price and would rarely be the cheapest option per unit.
  • Obsolescene with many of the end use products, such as medical, military, and commercial electronics. 
  • Nobody gets fired for buying IBM type industry: No patent protection yet largely Oligopoly industry structure driven by reputation as engineers spec into IEH and Smiths Interconnect again and again onto aerospace and other programs.
  • CEO seems hungry. When asked what gets him up in the morning he'll tell you that he likes to sell. He's noted for sitting in and/or running sales meetings even in CEO role. Since taking over in 2017, sales have grown from $19MM in calendar 2016 to $30MM in calendar 2019. EBITDA doubled over the same time frame to $7.5MM or 25% margin. 

Ownership

IEHC is a 4th generation owner-operated business. David Offerman, the great grandson of the founder, has been CEO since March 2017.  David has been with the company since 2004 on the Sales side and took over at age 42 when his father Michael passed away in March 2017. Michael had been CEO since 1987. David owns 129,783 or 5% of shares per the company's 10/2019 proxy, and options to purchase another 225,000 shares at $20/share that vests over 3 years at 75,000/yr. The Offerman family also owns another 900,911 shares or 37%, in the estate of his Gail - David's mother - and his father. David has at least one sibling who works outside the finance field and is presumably a beneficiary of the estate, providing some protection that dilutation (despite Offerman voting influence) should be minimal - in terms of anything beyond the recent 225k option award to David this is discussed further below. David has managed teh company well during his short tenure as CEO, growing sales, earnings, and cash flow; with total compensation <$400,000 each year aside from the July 2019 options award. 

The other large shareholder is Zeff Capital (founded by Daniel Zeff). Zeff is a small cap, value-oriented hedge fund. Zeff Capital owns 325,000 shares or 14%, first establishing ownership in circa 2013-2014 based on Zeff investor letters and 13G filings. The original 2014 13G ownership disclosure was 123,000.

Business Overview

IEH makes hyperboloid connectors, which are highly engineered, high-contact, shock-proof durable connectors used in various so-called mission-critical environments, primarily commercial aerospace and defense. 

In many cases, the IEH designs a product based on a customer request with a handshake or best efforts indication around lifetime program volumes. The company sells directly and through distributors. Direct sales to OEM are approx. 90% of total revenues. 

The company has customer concentration with two customers representing ~30% of total sales, approx. half to each customer. International sales are 18% of total. The company has always had high customer concentration owing the high-volume nature of certain OEM programs.

Prior to COVID, the company reported being tight on production capacity, was investing in new production equipment that would increase automation, and had vetted additional production space. 

The company's commercial aero and O&G buyers are struggling (totaling ~40%) but IEH has seen growth particuarly in its Military segments. Recently, the Air Force's Skyborg program was awarded to several manufacturers as the military seeks to upgrade its air fleet to include Unmanned Aeriel Systems to assist piloted fighter jets. These types of air systems require lighter and smaller connectors but also greater data transmission given remote or even automated/team/swarm flying aspects.

In commercial aerospace, the company is on both airbus and boeing single aisle programs, potentially more likely to recover than international flight volumes.

The company's sales by industry were as follows as of Sept 2019.

Defense........................50% (vs. 40% in 2017)

Commercial Aerospace....33%

Space.............................8%

Oil & Gas......................4.3%

Medical.........................4.1%

 

Misc.............................0.5%

Misstatement with Expensing Options Award

It was noted on the prior IEHC writeup that the failure to expense the award is not necessarily "immaterial". In July 2019, 225,000 shares were granted as option to purchase at $20, vesting in three annual installments of 75,000/yr. The award - although not properly expensed in the Income Statement - was in fact disclosed in a 7/31/19 through an Employment Agreement filing attachment (https://www.sec.gov/Archives/edgar/data/50292/000117494719000924/ex10-1.htm) AND also through an 8-K filing (https://www.sec.gov/Archives/edgar/data/50292/000117494719000924/form8k-22540_ieh.htm).

 

Fair value at the time of grant was $2.275 million using 55% volatility and 5.5 years life assumption, the $20 strike was where the stock was trading at the time, following price gains. The stock was ~$12 in the year prior, July 2018 and ~$6.50 in July 2017.

SEC communication was published where the company noted the misstatement was around an estimated expense rather than a cash expense, and given the larger earnings picture, and trend, it should be considered immaterial (in their opinion). 

Other notes

Geoff Gannon and his spokesdude Andrew Kuhn, collectively the Focused Compound team, discussed IEHC in Mid-March 2019 with a bearish opinion, citing trust issues and inventory build. https://focusedcompounding.com/ieh-corporation-iehc-may-be-a-good-cheap-stock-but-definitely-in-the-too-hard-pile-for-now/. However, if you lag inventory versus the sales that inventory generates, or do the CFA style beginning/end inventory average versus period sales, the increase is less alarming.The other reason for the increase is greater product/customer diversity which has been a strategy of David's - to stay focused in hyperboloid connectors but expand sales into new end users and new industries. 

The post-mortem is mixed. Inventory has grown since then, to $14MM. Raw material has grown to $10MM. And balance sheet cash is up from $1.4MM at 12/31/2016 to $8.1MM at 12/31/19. However, the company has grown sales. The company has grown backlog at each annually-reported interval, with 3/2019 backlog at $18.4MM, vs. $15.7MM for 2018 and $9.1MM at 3/2017. In other words, inventory has grown by ~40% from $10MM to $14MM over the 2017 to 2019 period, Sales have grown by 50%, and backlog has grown by 100%.

The pair also noted the auditor issue. It's worth reading. However, the violation was due to objectivity in that Jerome Rosenberg had assumed quality review responsibilities for the audit while also performing underlying audit work.

Another criticism is that the company suspitiously screens too well as a microcap, as if its managed or financial are manipulated to do so: Strong inside plain vanilla ownership, growing revenues and earnings, strong cash position, etc. All you have to do to get comfortable that Offerman isn't a stock promoter is pull of their investor presentations. It looks like a powerpoint homework project that my 5th grader did during Covid virtual learning. Right-click and pull the embedded data from any pie chart and the author of the excel sheet is David Offerman. Yet, their product catalog books are pristine. This is consistent with other material - the company has great product quality and reputation with customers, and puts very little money into corporate offices and little effort into a slide deck apparently. 

Valuation

IEHC trades at 1x Sales, 4x EBITDA and 5x EBIT. All these figures are based on their most recent filed financials which were 12/31/19. If IEHC were to trade at even half the multiples of Smiths Group - and IEHC has better growth profile and higher margins - shares would be 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • Continued growth in operating results
  • 3/31/20 and eventually 6/30/20 results may show the company less sensitive to commercial aerospace, continued military growth
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