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Sticks and stones – Austal Limited (ASD)

It’s the stuff Hollywood movies are made of – usually starring a short good looking religious nutter named Tom. A tense Machiavellian plot involving competing super powers, playing out with big bang special effects in a cinema near you. This time the exception, and there is always one, is that the story is being told on major newspaper front pages and heading TV news bulletins.

Australia’s prime minister warned we must prepared for a new reality – “a poorer more dangerous and more disorderly world.” This sobering peace time assessment echoes Labour World War Two PM John Curtin who redirected Australian troops to PNG to fight the invading Japanese, incurring the wrath of Winston Churchill.  Australia discovered then it was a big country to defend – remember the Brisbane line? And so, our government plans an additional defence spend of $270 billion over 10 years.

“We must face that reality, the patterns of cooperation that have benefited our prosperity and security for decades, are now under increasing and I would suggest almost irreversible, strain,” he said. Mr Morrison also conceded relations between China and the United States were “fractious at best, as they compete for political, economic and technological supremacy”. “It’s not just China and the United States that will determine whether our region stays on path for free and open trade,” he said, “We don’t seek to entangle or intimidate or silence our neighbours. We respect their sovereignty. We champion it. And we expect others to respect ours.

Sabre rattling can have the desired effect. Shareholders in locally listed shipbuilder Austal are experiencing this firsthand, as the United Stated Department of Defence (DOD), under the Defence Production Act beefs up critical navy infrastructure. Austal said it will receive US$50mn as part of the US government’s efforts to sustain and expand its Alabama shipbuilding base through COVID-19.  Austal will likely match the government contribution, bringing total investment to US$100mn over the next 24 months. Austal’s share price has ricocheted between $2.80 in May and a June high of $3.70. Presently the stock is around $3.35.

The importance to Austal of the DOD commitment can’t be understated. It a reaffirms the company’s position as a preferred builder Navy ship builder – one of 7 active prime shipyards. And should drive further support for Austal as a critical Navy supplier of both aluminium and steel ships.  Which could mean some very big future contract wins. The US Navy programs are the key and comprise about 90% of group EBIT. Current orders underpin revenue to FY23/24.

So for a defence contractor, customers like the US Navy don’t come any better. And given the current importance of the US navy in places like the South China Sea it is highly likely the Navy’s budget for future vessel programs will be maintained.

As a defence contractor, Austal, is considered an “essential critical infrastructure” employer whose operations are expected to continue as restrictions are placed on other non-essential businesses. It is likely Austal will receive the same status in Australia.  

Revenue is expected to increase from around $1.7 billion to over $2.3 billion over the next 2 years. Beyond that growth rests with new Navy contracts. And that seems a pretty fair bet to make.  Earnings per share should get a decent clip along increasing from around 17 to 24 cents over the same period. Dividend yield is a conservative 2.3%. The balance sheet is very strong with over $420 million in cash and cash equivalents. But it needs to be given the size of the contracts and having the financial firepower to complete.

Given Austal’s position with the US Navy and DOD, we think a share price of over $4.00 represents that optimism for the company.

And a sobering note on inevitability of conflict from Albert Einstein – “I know not with what weapons World War III will be fought, but World War IV will be fought with sticks and stones.”

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