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Austal contract hits choppy waters

Andrew Main
Wednesday, July 06, 2016

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By Andrew Main

Shareholders in Perth based shipbuilder Austal had an attack of the queasies on Monday on news the company’s biggest single contract, the $A5.3 billion trimaran contract with the US navy, had officially hit choppy waters.

The shares dropped 10 cents, or 8.3%, on news that the group had had to write back its revenue and the value of its Work In Progress (WIP) because of extra work required on the six vessels currently under construction at its yard in Mobile, Alabama.

The overall contract is for 11 of the very futuristic-looking trimarans.

Austal now expects to book a full-year loss of between $116 million and $121 million for the financial year just ended, after write-downs of $156 million.

However, it still plans to pay a final divided of two cents a share and is anticipating EBIT earnings for FY17 of between $45 million and $55 million.

Before the seesaw ride began, Austal earned an equivalent EBIT of $84.8 million in the 2014-5 year.

The big drama, which has been in the wind since late last year, is a consequence of the US Navy’s decision to test the hull of the first of the LCS (Littoral Combat Ships) completed, the USS Jackson coded LCS 6, by letting off a major underwater explosion within 50 metres of the hull.

What appears to have happened is that although the USS Jackson has now got through two of the three planned shock trials, more work will be needed on it and the other partly-completed vessels to satisfy Uncle Sam.

To give you an idea of how demanding these tests are, Austal has had to make more than 5000 modifications to the design, with 98% of them now complete on the guinea pig vessel.

The next ship in the contract, the LCS8 which was recently delivered, will have even more changes. But the company notes that by the time they get to LCS20, the final vessel in the current contract, the changes will be far fewer.

As management explained in the presentation on Monday, the cut in the earnings estimate was because “too much revenue and profit was attributed to work already completed,’’ while the Work in Progress valuation was overstated “because additional costs will be incurred to meet the shock standard and US Naval Vessel Rules.’’

That’s most of the bad news. The price recovered somewhat on the revelation that the US navy will share costs incurred in the trials, although an early recovery yesterday stalled and the shares closed down 1.35% at $1.10, in line with the market.

Despite the major push by what’s left of our political leaders to champion high technology manufacturing, this is one of a precious few locally based companies actually doing it, and the stock is only followed closely by two brokers, Macquarie and Ord Minnett.

At least they both like the Austal story.

Macquarie has an Outperform on the stock and a target price of $1.37, taking a positive view on margins on the LCS contract. Its report on Tuesday noted that it recognised a margin of 5.5% with that likely to climb to 5.7% in the year just begun.

It points to some uncertainty in the eventual size of the USN’s LCS requirement, in that the current Washington administration instructed the Navy to cut it back from 52 ships to 40 and that it wants to select just one builder in the 2019 year, “but this decision has largely been reversed in the current budget bill.’’

“Macquarie suspects the next administration will probably make the eventual decision”, which of course means no one really knows, but if the cards fall the right way, it could yet be very big indeed for Austal.

The company made it clear on Monday that even though margins on the first few ships in the US contract are going to be clammy, and it’s still working out how to incorporate the changes in the ships , “LCS is expected to be profitable over the remaining life of the program.”

Ord Minnett describes the size of the write-down as “significant”, but as it puts diplomatically, “earnings expectations have been re-based and Ord Minnett expects the incremental positive news flow should lead to positive revisions in the future.”

“Accumulate rating retained,’’ it states, with a target price of $1.44.

For an investor looking at the stock, it’s clearly got some risk, but Austal’s actually been around for decades, has completed more than 200 vessels various, and now builds in three locations including a small operation in the Philippines.

Any intrepid traveller who has been on for instance, inter-island ferries in Indonesia, can tell you that the eventual global market for fast, safe catamarans is very big indeed. Although Austal’s inevitably moved its main focus to those big defence contracts, there is a huge amount of civilian potential out there because of the high-speed, low-fuel consumption and low maintenance that aluminium multihulls demonstrate.

There is a consensus EPS on the stock for the year just begun of 8.1 cents (after minus 11.8c for the clearly forgettable 2015-6), which puts it on a PE of around 13 and a yield of 3.2%.

In these low growth times, it’s clearly a stock to consider.

Published: Wednesday, July 06, 2016

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