Hey there,
I am now a lucky Austal owner. After much deliberation I purchased ‘me’ some shares, as such I thought I will share my thought process and please good people of HotCopper challenge me on it if you disagree.
I would like to first start with - why market sees this stock to be lower than its intrinsic value. On 10th December share price dramatically decreased from $2.28 to $1.70 in one trading day. The news was about difficulties Austal was experiencing with LCS 8 & 10 which would lower its EBIT margins. Firstly, this is indeed a valid reason to be anxious about as LCS is a single biggest contract Austal has and its success will result in great profits for the company. But Austal has actually mentioned during their FY15 annual report (see page 5) that this is to be expected for both LCS 8 & 10, so surely for those who follow the company lower EBIT margins are not a surprise. At the time of the annual report they were at 5.2% for US business hence for FY16 we should expect around the same number. Alas, with H1 FY16 results margins are 5.5% (please see H1 16 Investors Presentation slide 10). This actually is an improvement on the margins from prior period albeit mostly due to FX gains. The counterargument could be that around the same time (17th December) US defence secratery wanted to cut the program from 52 ships to 40 and have 1 ship builder instead of two (Lockhead vs Austal). If that is the case, it is most likely Austal will lose the battle and will be cut out of the program. To this I will argue is that House of Armed Services passed a bill to uphold the current 52 ship order and still to have both ship builders delivering the vessels. The fate of the program will not be decided until US spring time which is, if you follow US politics, is election time. What are the chances that Senate will want to cut 4000 jobs in city of Mobile, Alabama that has population of 200k. Apart from probably Wallmart, Austal will be one of the its top employees which would be a PR nightmare for any candidate. It is more likely the program will live in its current form with 2 contractors working on the ships until all 52 are built. Regardless of the outcome Austal is still contracted for 7 ships now at the minimum and has high margin support contracts for these ships.
Second price drop was on 11th January from $1.44 to $1.19 due to exit of Austal CEO. Given almost 8 years Mr. Bellamy was a great CEO no doubt, but Mr. Singleton was on Austal board since 2011 and worked in AMS (JV between BAE and Finmeccanica) as a CEO and was head of strategy in BAE. Given his understanding of Austal business through his directorship role and managerial experience in other companies he does not seem to warrant a 17% drop in share prices and later even further to almost $1.
As for financial side of the company, using DDM I arrived at $1.49 provided dividend in FY16 will remain at 4c and will grow to 8c in FY19 to dividend yield of roughly 5%. Terminal growth was 2% and Re was 6.87% with time horizon of four years. Again this is a very rough and worst case scenario calc since company is reducing its debt and has no CAPEX in its sight this is an achievable goal. Nevertheless, DDM will undervalue stock for companies that are not yield companies and still in phase of growth which Austal is. So we can take that $1.5 is broadly a support price below which company will clearly be undervalued.
As for multiples, which I very much don’t like, Austal is trading at P/Book 0.8x which basically means if we would sell ASB for all of its assets it will be undervalued by almost 20%. This quickly implies share price of $1.56 using 1.0x P/B, as company has no significant financial distress, bankruptcy or earnings problems. Again, this is a very bear scenario as current capital goods industry P/B is around 2.3x giving Austal a great upside. These coupled with DCF mentioned in earlier post puts Austal between $1.49 and $1.99 in worst-to-base scenario. Given that the company was around 20 odds years and has experience in getting orders it makes me as certain, as you can get in in share market, that it will have few more orders coming its way which will push its valuation even higher than my current estimate.
Will be glad to hear from good people of HotCopper their thoughts.
Cheers,
Ed
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