Australia | Feb 14 2013
-Austal regains broker focus
-Adapted quickly to conditions
-US orders of prime importance
-Diversifying also key
By Eva Brocklehurst
Austal ((ASB)), the designer and manufacturer of combat ships, ferries and patrol boats, is receiving renewed broker attention. JP Morgan has re-initiated coverage with a Buy rating and 96c price target, joining Macquarie on the FNArena database. Macquarie recommenced coverage last month with a Buy and a $1.23 price target. Macquarie had a Hold rating last year in the wake of the annual results, before temporarily ceasing coverage ahead of the company's stock issue.
The ship builder hit a wall in 2008, with the escalating Australian dollar and Europe's descent into debt crisis. The surging currency was hurting its Australian production base and its formerly healthy order book of ferries to Europe was under the knife. The company was decisive. Instead of closing Henderson shipyard in Western Australia it became a naval defence manufacturing operation and Austal opened a more cost-effective Philippines facility at Balamban for the production of commercial vessels. Austal then moved to restructure its business to account for less demand in the high speed ferry market. It raised capital to shore up its balance sheet, extended debt and then sold one of its remaining luxury stock boats, thereby paying down some debt.
Now it's a matter of executing on its contracts. Austal ((ASB)) has a significant order book at over $2 billion and the potential for increasing returns over coming years. Macquarie believes the high Australian dollar continues to pressure Austal and the Australian yard will only break even in FY13. It's the US earnings that are key to its future. JP Morgan believes the risk/reward is there for investors with a medium term investment horizon. Austal has contracts with the US Department of Defense out to 2017 and potential for that to go to 2030 (if it's awarded a further 24 Littoral Combat Ship orders). While Austal only generated a 3.6% earnings margin in FY12 in the US, the vast majority of investment has now been made and JP Morgan can see upside to margins over the next couple of years.
The order book with US Defense may be small beer in terms of the overall budget, but to Austal it's significant. The contracts fall into two main camps – Littoral Combat Ships (LCS), where Austal has secured at least 10 ships in a block contract, US$5.0bn worth, and Joint High Speed Vessels (JHSV) where the contract is worth US$1.6bn. JP Morgan also sees scope for an increase in JHSV orders. Since 2006 Austal has fully owned the US shipyard in Mobile, Alabama, one of the largest in the world, where it has invested $400 million and obtained substantial government contracts. The downside to all this, of course, is any reduction to US Navy spending plans as a result of cuts to the US budget.
In August 2011, ASB was awarded a contract to design, build and through-life support for eight Cape Class patrol boats for Australian Customs and Border Protection Service. The $330m contract sees the boats delivered between March 2013 and August 2015. This contract is extremely important as it is testament to the company's capabilities and somewhat, in JP Morgan's view, justifies the company retaining its Henderson facilities. The broker believes, with the successful delivery of the Cape Class boats, further opportunities exist for similar vessels in other regions, particularly in the Middle East. Macquarie also maintains, with the increased attention on piracy globally, these patrol type craft will be in demand.
Austal is also branching out into defence systems work following the acquisition of ATI in November 2010 and has made a joint bid for the ANZAC-class frigate communications upgrade. In October last year it acquired Hydraulink NT and associated business KM Engineering, which support the Royal Australian Navy and Australian Customs. This company has operations in Darwin and has close ties to the oil and gas sector.
JP Morgan and Macquarie are the only two brokers in the FNArena database currently covering the stock.
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