Austal Limited (ASX:ASB) is a highly regarded business and leading manufacturer of high speed passenger and vehicle ferries, luxury yachts and an increasing portfolio of naval and para-military vessels.
Sales for FY09 were $500.4 million with a Net Profit after Tax of $9.2 million. The net profit was adversely affected by a number of events. These were the previously announced $29.9 million Hawaiian super ferry loan write off, delays in commercial vessel contracting and $14.8 million unrealised loss on foreign exchange options (hedging).
ASB has shipyards in both Australia and the United States. 2,200 employees are currently delivering the most substantial product base of any shipbuilder to locations all over the world.
It wasn’t always this way. ASB dates back to June 1987 when Austal Ships Pty Ltd was founded by boat builder John Rothwell. The business began with around 40 employees in Perth, Western Australia.
Initially the Asian market was the key focus, with profitability in the early 1990’s being driven by strong demand from China and Hong Kong. An order book of two dozen 40-metre passenger catamarans and a new range of high-speed vehicle ferries generated annual sales of around $85 million.
Six years after inception, and following further expansion in export sales to
the United Kingdom and Japan in 1993, ASB attracted the interest of venture capitalists who acquired a 30% stake in the business. A capital injection of some $15 million allowed an expansion of existing ship yard facilities and further investment in technology to be undertaken. This immediately sped up production and boat building capacity.
Notably, over the next three years to 1996, employment tripled to keep up with an increase in manufacturing capacity and an increase in demand. By the end of the decade ASB was exporting to Scandinavia, Greece, Turkey, the English Channel and the Irish Sea.
Further capacity was purchased in 1998 when ASB acquired Image Marine. Then the decision was made to list on the Australian Securities Exchange under the shortened name of Austal Limited. At this time the business had 1,000 employees, sales of around $196 million per annum, and had just entered the patrol boat market. This move soon cemented their place as a leading builder of patrol vessels.
The financial crisis in Asia and a slowing global economy pulled on a hand brake shortly after, as demand for new ferries slumped. Management looked at ways of diversifying their previously profitable ferry building operations and settled on the acquisition of Oceanfast Limited. This saw capacity added to produce smaller ferries and luxury motor yachts.
Hindsight would reveal that this diversification came at a significant expense. Oceanfast Limited was clearly not immune to the downturn in the business cycle. Sales of $50 million in 1996 quickly slipped into uneconomical performance and a few years later consolidated profitability was driven into the red.
Further investment was undertaken in 1999 when a partnership with Bender Shipbuilding & Repair Co (US) lead to the establishment of a shipyard in Alabama with the aim of sourcing business from the United States. The investment paid off when ASB won a contract to supply the US military in 2001. ASB was the first company to supply the US military with a high-speed vessel, the Theatre Support Vessel (TSV). Since this time the US military has fuelled the growth of the company and will continue to do so in the future.
Looking back, this was a turning point for ASB. The opportunity opened the door to a stable source of demand with a government budget committed to spending billions on upgrading and building a larger, modernised war machine. The benefits however were not immediate, as we will discuss below.
With over a decade of offshore activity, it was only in 2002 that ASB was put into a position to provide one of its ferries to a local operator in South Australia. Coincidently, this was around the same time that Incat, a main rival for leadership in the high-speed ferry market, went into receivership. Today, ASB is well placed to meet the requirements of a global market.
Figure 1: StockVal Valuation – Austal Limited (ASX:ASB)
Prior to our five year review period, profitability of ASB was inconsistent, primarily reflecting the fact that boat building is a volatile industry and subject to economic conditions.
For instance there was a $18.7 million of net losses in 2002-03 fiscal year due to project cost overruns associated with a great white shark, two other vessel deliveries and red ink at the then newly acquired US facility. The business recovered in 2004 and since then earnings consistency, as evidenced in the above chart, have improved dramatically. Coincidently, this was also a period when military orders significantly increased. The order of 10 patrol boats by the Republic of Yemen and our own Royal Australian Navy order of 14 Armidale Class patrol boats over a period of four years all came online.
The US Navy’s Littoral Combat Ship (LCS) and Joint High Speed Vessel (JHSV) contracts see greater earnings visibility as a growing military order book has significantly reduced dependence on the cyclical commercial fast ferry market. Therefore, economic performance had clearly improved in the four years prior to last year’s disappointments.
Over the five year review period the reinvestment of capital back into the business has seen shareholders equity grow from $135 million into $218.7 million at the end of FY09. Return on equity has consistently been close to 30% excluding FY09.
A majority of the company’s revenues over the coming years are forecast to come from military sales. ASB has converted itself from a commercial shipbuilder to a fully fledged US Navy contractor and this seems to have resulted in lower earnings volatility.
ASB spent US$56 million of capital expenditure during FY09 expanding their US infrastructure. The total cost of the expansion was US$88 million with the government contributing US$33 million through an economic stimulus package. Additional assembly bay and office facilities will be required in FY10 to support the US defence contracts.
Figure 2: ASB Planned US Expansion
ASB predicts that contracts on hand (currently $850 million) will surpass $1.5 billion by the end of FY10 driven mainly on the back of US defence contracts. The table below shows the current planned defence award schedule.
Figure 3: Defence Department planned award schedule
The effect of winning just one or two of these contracts is substantial to ASB. For each LCS contract they win, we estimate they would book US$175 million of revenue and for each Joint High Speed Vessel (JHSV) they would book US$120 million.
The current share price is $2.58. StockVal values the business at $2.59. This valuation is based on Equity per Share (EQPS) of $1.25, forecast return on equity of 25% and an investor’s pre tax required return of 13.8%. Think about it like this, if you invest $1.07 into a business and it generates 25% annually and you are happy with 13.8%, you can pay around two times equity for that $1.25 based on StockVal ‘s proprietary intrinsic valuation formula, or $2.58. If you lower your Required Return in StockVal (given the risks associated with this business that would be hard to justify) to 13%, the valuation rises to $2.79.
Comments from management around the order book and the future pipeline are all positive. If they deliver in terms of contract wins there is upside to our valuation.
Recent US Government Announcement
The recent price decline has been due to an announcement by the US Navy that it will replace the current tender process for up to three LCS ships with a new request for proposals for a 10-ship, four year award. The successful company will be awarded two vessels in FY10 and receive options for eight additional vessels in the following years. This contract is therefore crucial to ASB.
It will be interesting to see how the future pans out – it is looking very positive at the present point in time. ASB has transformed itself from a commercial boat builder to a government contractor. The order book looks strong and there is the strong possibility of the order book growing through US defence contracts. We see good value below $2.50.
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