Description

Overview

Over our firm's 30+ year history we have remained staunch Graham and Dodd investors through thick and thin: more thin in recent years than we would like. Our general approach is that by buying smaller companies at enticing valuations we are, through constant diligence, able and willing to hold them for many years. Sometimes the end markets grow faster than we initially underwrote and usually, at some point, markets become ebullient and afford them multiples that are too rich for our taste. In a few cases (one of our top positions was initially acquired in '89) the businesses tend to be better than we thought, management more capable than we thought, and the runway far longer than we had hoped. Unfortunately these traits are awfully hard to forecast a priori. With Eastern we think that two of the legs might be covered (business quality and management), a transformation is well underway that, due to Covid, is being masked, and we are able to own a fractional share in this enterprise at deep value type multiples.

Thesis

Eastern is an under-the-radar 'conglomerate' with a long history of snooze-ville. It was historically a business cobbled together without much rhyme or reason and, as such, had a mediocre competitive position in 10-15 disparate business lines. While it was culturally conservative from a financial perspective, there also wasn't much focus on increasing shareholder value. That changed about five years ago with the tenure of a new management team. Gus Vlak was a consultant to Barrington Capital (one of the firm's largest holders) and has rather seamlessly made the transition to the ceo position; bringing a seriousness, fine focus on returns on capital, and general engagement that was lacking before his arrival. As such, we now have a company with three strong business segments, poised to grow, three remaining 'bad' businesses that will likely be sold or harvested for cash, and a capital light model that should generate meaningful cash flow in relation to the current market cap.

Business Lines

Big 3 Precision: Eastern acquired the company late in 2019 for a tad under 82mm. In the 8k filed after the transaction they assigned a 6.1x multiple to 13.4mm of adjusted ebitda (excluding management fees and one-time transaction expenses).

https://www.sec.gov/Archives/edgar/data/31107/000003110719000029/ex99_6presentation.htm

Big 3 is a custom molding company with meaningful exposure to auto and consumer packaging.

http://www.big3precision.com/blow-molding-division/

The consumer business has performed above plan during the pandemic and, it's not a coincidence, that the home-page has pictures of hand sanitizer containers. 

Their auto business is highly geared to new model launches and the industry outlook writ large is more favorable than at the time of the acquisition.

Eberhard/Illinois Lock Company: a leading manufacturer of latches and locks. This past year the two companies combined and we believe there are still expense synergies to be realized. While this segment, again, is tied to the health of the auto market, it touches lots of industries including health care, gaming, and tech.

 https://www.eberhard.com/

 https://illinoislock.com/

Velvac: https://www.velvac.com/

Velvac is predominately a maker of mirrors and smart camera systems for RVs, trucks, and commercial vehicles. We keep an eye on the Class 8 truck data which is a good indicator of the health of the market: https://fleetimages.bobitstudios.com/upload/trucking-info/content/news/2021-02/ftr-jan21-orders-__-720x516-s.png . While the mirrors are fairly standard there's definitely some IP involved in their smart camera (road IQ) product line. As with Big 3 Precision, the slate of new vehicles in the coming years bodes well for this business line.

Non-core assets: https://www.frazerandjones.com/, https://greenwaldindustries.com/, http://argoems.com/. I won't touch on these businesses since it's now clear that they are either in wind-down mode or will be monetized. This speaks to Gus's operating discipline and insistence on higher ROIC, higher margin businesses. 

Valuation

The way we think about normalized earnings is by taking the pre-Big 3 acquisition level of EBITDA generation and adding in the acquisition. That results in about 40mm of EBITDA. From that we deduct 2-3mm in interest expense, tax effect it at 25%, and subtract 4-5mm in capex, which results in about 24-25mm in free cash flow. That is a robust 16% yield on the current market cap and doubly so given the interest rate environment.  That should also translate into about $3.50 of eps power or 7x the current stock price. Management's long term goal is to create a 100mm EBITDA company through organic growth in their three main business lines and by bolt-ons. Given the free cash flow generation of the company we think that they can achieve this with a healthy balance of leverage and ongoing cash from operations. 

Management

While not an explicit bet on the jockey, the investment does rely on the continued financial acumen of Gus Vlak. He has thoughtfully positioned the company whereby it now will succeed (or fail) based on the results of the three businesses listed above. He has reduced costs, improved working capital terms, and grown the free cash flow generating ability of the company threefold since his arrival. We are confident that the current path makes the most sense and would expect further portfolio dispositions/repositioning in the future. He is conservative in nature and believes that while the stock is materially undervalued at current levels, his job is to continue executing and trust that eventually the market will get it right. That said, they just presented publicly for the second time at the Sidoti conference and they are committed to being a bit more public facing going forward. 

Financials

 THE EASTERN COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

Shareholders

While Barington is known for some of their previous activist campaigns (Avon, Chico's, L Brands, etc.) the founder, Jim Mitarotonda, sits on the board of directors and has a constructive relationship with Gus, whom he used to employ. We believe Barington is a long term holder and our understanding is that the funds that are invested are those of the principals and they view this as a platform for multi-year growth.

Conclusion

Eastern is the kind of company we gravitate towards: a niche industrial trading at an attractive price run by capable operators. We believe this is now a 'platform' company with a long runway ahead of it and would expect to own this for many years.

Catalyst

• A normalization of the operating environment such that the latent earnings power can become evident
• Continued free cash flow generation
• An increased focus on investor outreach