With recent headlines a source of considerable alarm, many investors may have wondered if Australia has defence stocks that could benefit from an upswing in military spending. While this kind of investment will not be every investor’s ethical cup of tea, the fact remains that defence is a major industry, and an area in which Australia shows expertise, capability and technological prowess. Here is a look at the ASX’s five top defence stocks.
Austal (ASB, $1.57)
Market capitalisation: $549 million
Five-year total return: 3.8% a year
FY18 forecast dividend yield: 2.55%, fully franked
Analysts’ consensus target price: $1.89
Perth-based shipbuilder Austal (ASB) is the doyen of listed defence contractors, and is Australia’s only listed shipbuilder, with manufacturing facilities in Australia, the Philippines and United States. Austal has become an important partner of the US Navy, with two major contracts, the US$5 billion ($6.2 billion) Littoral Combat Ship (LCS) contract and US$1.9 billion ($2.3 billion) Expeditionary Fast Transport (EPF) vessel contract.
Designed to operate in shallow waters close to the coastline, the LCS is the fastest ship in the US fleet. Austal designed and built the USS Independence-class vessels as one of two LCS suppliers: the company has built six ships under this contract, with eight more to come. Last month, Austal’s shipyard at Mobile, Alabama, delivered its sixth LCS, USS Omaha, to the Navy.
The Expeditionary Fast Transport (EPF) contract is for 12 high-speed transport vessels for the US Army and the US Navy. So far, Austal has built eight of these ships, with the most recent, the USNS Yuma, delivered to the US Navy in April.
Austal is the only foreign company ever to have designed and built warships for the US Navy. In June, Austal won a fresh $780 million contract to supply an additional LCS, ahead of Lockheed Martin’s competing Freedom-class variant. By the time it completes the LCS and EPF contracts, Austal will have delivered more than 15% of the US Navy’s surface fleet. The company will be working until 2022 on these contracts.
The company also has a US$125 million ($156 million) contract to build two High-Speed Support Vessels (HSSVs), an all-new design developed for the Royal Navy of Oman. At home, Austal has also delivered 72 patrol boats over the last 18 years to the Royal Australian Navy and Australian Customs.
More than 80% of the 255-plus ships Austal has built have gone to overseas customers – which makes it Australia’s largest defence exporter. It is the world’s largest aluminium shipbuilder. Austal is currently working with German designer Fassmer on its bid for the three-way battle for the $3 billion tender to build 12 offshore patrol vessels (OPVs) for the Royal Australian Navy (RAN): a decision is expected by the end of the year, with construction to begin next year in Adelaide for the first two boats before shifting to Perth in 2020, for the remainder.
Austal has stated that failure to win this contract would “seriously impede the future viability” of its Australian operations, and could lead to partial or full closure of the Henderson yard in Perth. Further out, the company has teamed with ASC Shipbuilding on a bid to build ships for the RAN in the $35 billion SEA500 Future Frigates Program, which it says would “secure the future of naval shipbuilding in Australia for decades to come.”
On the commercial side, recent contracts in China, South Korea, the Philippines, Taiwan and Norway boosted Austal’s order book to $3 billion at the FY17 balance date. In FY17, Austal generated revenue of $1.31 billion, down 2.2%, and an underlying net profit of $32.7 million, up 31%; the company paid a fully franked dividend of 4 cents. Austal ended the financial year with a net cash position of $19.3 million.
Analysts expect a very strong year for Austal in FY18, with earnings per share (EPS) more than doubling. The concern is for local work – the OPV contract would be a major boost – and commercial work in general, given that Austal relies heavily on US Navy work: US operations generated 89% of revenue in FY17. The company is forecasting revenue of $1.3 billion–$1.4 billion this year, and analysts see plenty of scope for the share price to rise.
Source: ASX
Codan (CDA, $2.31)
Market capitalisation: $410 million
Five-year total return: 15.4% a year
FY18 forecast dividend yield: 3.77%, fully franked
Analysts’ consensus target price: $2.60
Communications technology company Codan is known mainly for its Minelab metal detection products – which generate almost two-thirds of its revenue – but the company has a growing business in HF/VHF/UHF radio communications products for the military/emergency services/NGO/security market.
Last year, Codan set up a defence division to capitalise on growing sales to the defence sector, with its radio systems, antennas and landmine detectors used by military organisations all over the world. In FY17 the radio side of the business had its best result in eight years, lifting sales by 9%, to $71 million, and profit by 14%, to $19.9 million, on an expanded military offering. The highlight of this was the introduction of two new handheld tactical radios for the global military market, Sentry-V and Sentry-H, both modelled on Codan’s leading-edge software-defined EnvoyHF radio. In July, the company’s new Cascade land mobile radio (LMR) product platform was launched.
Codan says it will bid into the largest defence projects coming up in Australia, including the upgrade of the Jindalee over-the-horizon radar network, the Army’s
Land 400 Phase 2 program, which will buy 225 combat reconnaissance vehicles (CRVs) plus the associated systems, and the Navy’s SEA5000 future frigates program.
In FY17, Codan’s revenue rose 33% to $226 million and profit surged 181%, to $43.5 million. The company generated $75.6 million in free cash flow, up more than 50%, and paid shareholders 7 cents a share in fully franked dividends (including a special dividend of 3 cents), up 1 cent for the year. Codan was debt-free at year-end.
This year, analysts’ consensus expects earnings per share (EPS) to fall slightly, from 20.7 cents in FY17 to 18.4 cents, but the dividend to rise to 8.7 cents, pricing Codan on a prospective yield of 3.8%. Analysts’ consensus is bullish on the share price.
Source: ASX
XTEK (XTE, 44 cents)
Market capitalisation: $20 million
Five-year total return: 11.6% a year
FY18 forecast dividend yield: n/a
Analysts’ consensus target price: n/a
Canberra-based XTEK describes itself as a “homeland security” specialist, the only such listed company on the ASX. It provides protective security, tactical and forensics solutions to the government, law enforcement, military and commercial sectors.
The company has its XTEK Tac2 Sniper Rifle System – which it describes as the world’s most advanced, modern sniper rifle system – in service with the Australian Army. XTEK has been working with the US military for several years with its XTclave technology, which produces stronger and lighter ballistic-resistant composites in complex shapes such as helmets. In June the company signed a $US644,000 ($845,000) deal to supply its lightweight combat helmets to ant-terrorism special forces in the US. Over the next 18 months, the US government’s Combating Terrorism Technical Support Office will be testing combat helmets and body-armour panels made using the XTclave technology.
XTEK is also working in the field of small unmanned aerial systems (SUAS) – otherwise known as drones – and in July the company signed its largest deal yet, a $42 million acquisition contract to supply and maintain a fleet of SUAS products to the Australian Defence Force (ADF). The company has also won smaller recent contracts to supply the ADF and domestic police forces with Explosive Ordnance Disposal (EOD) robots.
XTEK returned to profit in FY17, lifting revenue by 169% to $9 million, and making a $61,000 net profit. The company is building a new commercial-scale XTclave plant in FY18. No forecasts or consensus target prices are available for XTEK.
Source: ASX
Quickstep Holdings (QHL, 9.4 cents)
Market capitalisation: $53 million
Five-year total return: –9.4% a year
FY18 forecast dividend yield: n/a
Analysts’ consensus target price: 21 cents
Sydney-based composite-materials specialist Quickstep Holdings Limited (QHL) is something of an enigma: Australia’s largest independent maker of aerospace-grade, advanced composites, whose carbon-fibre parts are trusted for the US-led F-35 Lightning II (Joint Strike Fighter) program – but it cannot make a profit doing so.
In February 2011, Quickstep signed a long-term agreement with Northrop Grumman Corporation to make parts for the Joint Strike Fighter (JSF) aircraft, which will be flown by the Royal Australian Air Force (RAAF) as well as ten other air forces. Quickstep makes 21 different parts for the JSF program: the supply agreement is worth up to $700 million to the company, over 20 years. At peak production rates, Quickstep says revenue from the JSF contract will reach $40 million a year.
Quickstep is also the sole supplier of composite wing flaps to Lockheed Martin for the new LM-100J commercial freighter, which is the commercial version of the C-130J Super Hercules military tactical airlifter. Additionally, the company is a member of the Team Reaper consortium, which is hoping to land the ADF’s Project Air 7003 armed remote piloted aircraft system (RPAS) contract.
The company lifted sales revenue by 4% in FY17, to $51.9 million, led by JSF volumes: it delivered 1,230 parts to this program, more than double the 590 parts delivered in FY16. But lower volumes of wing flap assemblies for C-130J offset the strong JSF growth (although the company says C-130J volumes “returned to normal” after increased deliveries requested by Lockheed Martin in FY16.)
Earnings (before interest, tax and research and development) was a loss of $200,000, compared to a profit of $1.3 million in FY16, driven by lower margins due to the changing program mix and impact of the learning curve. Research and development costs for FY17 were $5.5 million. After financing costs, the net loss for the year was $6.7 million.
The company forecasts its production volumes to increase substantially; current JSF production represents approximately 50% of FY19 forecast volumes and 45% of FY20 and FY21 volumes. As production and total sales continue to increase, the company says it will benefit from economies of scale and “improved profitability.” No forecasts or consensus target prices are available for Quickstep.
Source: ASX
Electro Optic Systems (EOS, $2.70)
Market capitalisation: $164 million
Five-year total return: 48% a year
FY18 forecast dividend yield: n/a
Analysts’ consensus target price: n/a
Queanbeyan-based weapons and space defence technology developer Electro Optic Systems (EOS) won a big order in June: a $170 million contract to supply its high-tech automated gun turrets to Orbital ATK, a Nasdaq-listed aerospace and defence technology company. The contract relates to EOS’ R-400S Mk 2 weapon system, which was launched on the market early in 2017. The R-400S Mk 2 is a single weapon station capable of operating a range of automatic weapons, machine guns, cannon and grenade launchers.
The R-400S-Mk2 product has been tendered for two other international customers, which have chosen EOS as their preferred bidder for contract negotiation. The company now expects to exceed $500 million in 2017 orders for the new weapon system. EOS is gearing up for the extra work by striking a deal to move to a larger manufacturing facility in Australia, which has a production capacity of $150 million a year: the company expects to be in its new premises from the first quarter of next year.
EOS says the R-400S Mk2 is a “game changer” product with an addressable market out to 2025 of US$4.6 billion ($5.75 billion). The company will follow this launch in 2018 with the R2000 remote turret system, which has an even larger global market size, potentially US$11 billion ($13.8 billion). EOS says the release of R-400S-Mk2 will attract sufficient orders in 2017 to double defence systems revenue annually, for some time.
Including the Orbital ATK contract, EOS expects to exceed $500 million worth of orders for the R-400S-Mk2 weapon system in 2017. Further out, even greater potential may sit in EOS’ technology to track space debris, a program that has attracted the support of military contractor Lockheed Martin.
EOS made a loss in FY17, but easily raised $21 million last month, in an over-subscribed share placement, to help it fulfil the Orbital ATK contract.
Source: ASX
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