Austal Limited (ASB) Earnings Call Transcript & Summary

Good morning, everybody, and welcome to the FY 2021 Half 1 Results Call. I'm Paddy Gregg, the CEO at Austal; and I'm joined by our CFO, Greg Jason. And this is, of course, the first set of results that I'm presenting following the departure of David and the excellent transition that we had. And we will be presenting in the same format as we have done previously using the slide deck, with me giving business overview and context, while Greg focuses on the financial detail. As always, we plan to present for about 30 minutes to leave plenty of time for questions you may have. I think in summary, it's been quite a challenging months for us with COVID. But we made a decision early on last year to attempt to keep all our yards open and adhere to social distancing rules, and we've been very successful in doing that. We've seen some challenges with the strengthening Aussie dollar. But we're very focused on opportunities for long-term sustainable growth and profitability of the business and replenishing our order book to keep our facilities full and staff gainfully employed. And we hope you'll see that at the headline level today, we've delivered another strong half year earnings and profit in the past 6 months. But there are some movements in the detail. And so we've put some additional slides in the deck to really try and help explain what's going on in the segments. So without further ado, if we click on to the second slide, I'll talk through the financial headlines. I think in summary, these results demonstrate a really strong operational performance. The one thing that continues to receive maximum focus is replenishment of the order book and the associated revenue. And I plan to talk more about the opportunities as we see them, particularly in the U.S. later on in the presentation today. Standouts in the half for me were particularly increased shipbuilding margins from both the U.S.A. and the Australasia business. We had flagged that previously, but I'm pleased to say that we've delivered on what we committed to. Confidence in the balance sheet has allowed us to increase the dividend half-on-half and continue to invest in both organic and inorganic growth of the business. We've grown a really healthy net cash position of around $260 million, enabling us to deliver returns to shareholders whilst retaining the ability to self-fund investment and long-term growth opportunities. And we are investing for future shareholder returns, including things like steel shipbuilding in the U.S., growing our support business with the acquisition of BSE business in Cairns, just to mention a couple of things. In particular, I think the results demonstrate how the nature of the business are now being heavily skewed to defense and more diverse than ever before. We can withstand the current economic and operational challenges that face us. If we flick on to the next slide and look at the key facts for the business. We look at the revenue, and we'll talk more in detail on that and help explain the change, but some challenges with COVID, some FX headwind and coming off the back of what was a record year, and we have seen a reduction in revenue this half. We're also working our way through the order book. And while replacement is a key focus for us, let's not overlook the fact that we have 38 ships under construction or scheduled, and that is still a significant volume of work we have ahead of us over the next few years. I'm very proud of what our teams in the U.S.A. and Australasia business have done to achieve the delivery of 10 vessels. 5,800 skilled employees have worked tirelessly to make sure that Austal delivers on its commitments and return value to the shareholders. Many businesses have suffered during this time. But with a strong order book, we have a strong balance sheet, we entered COVID in a very fortunate position, and that can be seen from the results we're delivering here today. Our service and support business has had some challenges, but we see a bright future. And I'm pleased to say the BSE acquisition has gone well, and we're now up to 8 service centers worldwide, with 33 vessels under sustainment contracts. I'm now going to hand you over to Greg to talk through some of the detail of the finances.

Thank you, Paddy. Good morning, everybody. I'm going to go straight to Slide 5, which is the standard earnings headline. The really key items on this page are about the decline in revenue, which has gone down 19%, but the really substantial improvement in EBIT. There's a lot going on across the various shipbuilding and support activities in U.S.A. and Australasia this half. And so this time around, we've included a lot more content to help you understand the movement in those key parts from the first half of '20 to first half of '21. So let's go across to Slide 6. So this is depicting the $200 million movement in group revenue from first half '20 to first half '21. And approximately 25% of the reduction was due to FX headwinds on translation. About 40% was due to reduced throughput in U.S.A., and I've got a slide later on that I'll talk to again to more detail about that. We've also got a decline in U.S.A. support revenue. And again, more detail to follow in a few slides. Paddy talked about the decline in Australasia shipbuilding revenue. So we had 2 things going on. we completed and delivered 3 vessels during the half, we came down on level of activity on a couple of other areas, but we also had a net increase in the amount of patrol boat activity with the Cape-class 11 to 16 contract that was awarded May last year. We've had an increase in Australasia support revenue, and a lot of that was generated from emergent work that arose from docking that took place during the half to the Cape Class Patrol Boat fleet. Going to move to Slide 7, and this one depicts the movement in group EBIT from first half of '20 to the first half of '21. You can see overall that there's just over a $10 million increase in EBIT. We faced $4 million worth of headwinds on FX. The U.S.A. shipbuilding delivered a lot more EBIT in this period. Relative to the comparative period, there was a higher level of incentives as we delivered LCS 26. The team also realized a number of cost reductions, and we're able to retire some risks across a number of vessels as key milestones were reached during that half. U.S.A. support revenue -- sorry, support EBIT grew, but that was associated with some revenues coming out of 2020 activity. I'll strive that in a few slides. And we also had Australasia shipbuilding EBIT increase. This was also what we projected. And despite the decline in revenue, we saw an EBIT improvement and an EBIT margin improvement. And this is what we projected as we came off a number of commercial vessels that were low-margin in Australia. And whilst we've got less activity now, we've got a better suite of projects in the portfolio. I'm going to go across to the segment. I'm lost in my pages here. Going across to the segment breakdown on Slide 8. FX impacted U.S.A. revenue, $45 million in total revenue level, and $4 million at an EBIT level. Shipbuilding EBIT increased despite the FX headwinds and the EBIT margin increased 2 percentage points, and that was associated with the incentive, the improved cost performance and risk retirement that I mentioned a moment ago. I'll skip over U.S. support because there's some slides that support it, so I'll drop down to the Australasia section. Total revenue decreased, EBIT improved, as described. We have had a nice increase in the Australasia EBIT margin. We were 2.4% in the first half of '20. that increased to 6% in the second half of 2020, and that's gone up again to 6.4% for the first half of '21. We're not yet at the target band that we want to be in. We're still striving to get Australasia up into the 8% to 10% mark. Support revenue increased largely because of the emergent work that I described, and it was emergent work on the Cape Class Patrol Boat contract. About 3, 4 years ago, we had declared that onerous. And then in 2020, we were able to get to a point where that was no longer onerous, but it's still not a particularly profitable contract. And so a lot of that additional revenue that came through wasn't contributing a lot of margin to the group. And so that had a dilutionary impact on margin. And for the first half of 2020, also included some high-margin nonrecurring work. And of course, we didn't then get the benefit of that flowing into '21, and that also contributed to the margin drop. I'm going to Slide 9, which dives a bit deeper into U.S.A. shipbuilding revenue. So overall, there's a AUD 121 million decrease in revenue. About 1/3 of it was due to FX headwinds, 2/3 was due to the LCS program, and the rest was attributable to EPF, which was pretty flat. So within LCS, we've got a lower level of materials in the half, the first half of 2020 had a lot of long lead time materials associated with LCS 36 and 38, which was the last 2 LCS that we ordered. and we didn't have those types of long lead materials in the first half of '21. We also had a decrease in the level of labor hours on LCS as we're progressively building those programs. EPF had a factor each way. There was a lower level of materials, but there was a higher level of labor and netted out to just a slight decline in revenue period-over-period. So moving on to Slide 10. This is exploring U.S.A. support revenue in more detail. So you can see there's quite a considerable drop in revenue from the first half of '20 to the first half of '21. At a macro level, the primary concept that's going on is that we're not sufficiently entrenched in the ongoing annual maintenance of the LCS fleet at present. And there's 2 enablers that are going to let us break into that revenue stream in a more permanent way. The first of them is that we need to be admitted to the panel of sustainment execution contract providers on the West Coast of U.S.A., which U.S. refers to as SEC West. And the second thing we need to do is to establish an Austal-owned and operated dry dock in San Diego, so we can then self-perform the majority of the work as prime contractor. So the U.S. team is working, and very focused on that particular initiative so that we can drive revenue and earnings back up in the support segment. At a more detailed level, of course, there were FX headwinds on revenue. We were, or are, victim of our own success in a way because previously, the Navy was docking each of the LCS typically somewhere around the first year of service following delivery. But the Navy has canceled any further post shakedown availability docking because of the quality of the vessels that are coming out of Mobile. So good for the reputation, good for the name, but not so good for the support revenue and EBIT. There has been less LCS class support as that program is maturing through to the end of LCS 38. There were some design engineering studies done in 2020 on EPF. We also had the FFG design work in first half of 2020, which wasn't repeated in '21. Nice to have a green box at the end. So we acquired the MARRS assets, which are across the river from the existing shipyard in Mobile, and that has contributed additional revenue to the group following the acquisition in August. So I'm now going to talk about U.S.A. support margins. For those of you who have followed us for a while would have seen the rather volatile margins that we've reported. And the IFRS accounting for the support revenue has resulted in a number of revenue timing issues that can significantly distort the EBIT margin. And we've prepared this slide to show you the reported margin and also margins normalized for those timing differences. So we get timing differences through a number of factors. One of them is the timing of incentive award fees as they're granted by the Navy. Second can be the approval from the government of additional funding or cost-plus type jobs. We've also had delayed revenue recognition in some cases for the service jobs in Singapore as that service center started up. And in some instances, we had some negative impact in some periods as we booked some doubtful debtors. And that created a hit on margin. But then subsequently, the debt is paid and didn't turn bad, and so we got a pickup in the following period. So the top chart to fix the reported and the normalized EBIT margin. So the reported is the blue columns, and you can see them going up and down. The most stark example is the second half of '20 and the first half '21. And then the normalized margin is attributing the revenue and the profit back to the periods where the work was done. And you can see that the normalized margin is in the band of 6.8% to 8.9%. The bottom chart just depicts the various EBIT movement as part of that normalization that I spoke to you. If you add all the way across, it is a zero sum. We still see the ongoing margin in this business be as per the normalized line on the chart. And we've said for a while that you shouldn't look at an individual half to get a reading on how that business is performing. You should take a longer-term average to get a picture of it. Moving to cash flow next. So we had very strong conversion of EBITDA into operating cash flow. EBITDA was just over $92 million and operating cash flow is just over $93 million. We've had $43 million of enhancing capital, which includes the MARRS assets in Mobile, the BSE acquisition in Queensland and a dry dock for Philippines so that we have the capability of launching our own vessels. At a very simplistic level, the way you can think about it is that the operating cash flow generated in the half was sufficient to fund all of the growth initiatives in capital. It allowed us to immediately retire just over $7 million of debt that came with the BSE business and allowed us to pay $0.05 per share of dividend at over $17 million. Year-end cash balance was $372 million, very strong. It would have been higher had we not had the appreciation of the Aussie dollar and that brought down to a lower number. So we do have a lot of cash at the end of December, but we've got several hundred million dollars of that earmarked both for committed projects, such as the balance payments on BSE, remaining infrastructure upgrades required to accommodate the dry dock in the Philippines, the ongoing steel investment for Mobile. And we've also got uncommitted projects that we've referred to, such as the San Diego dry dock business and Subic Bay to come. Finally, I'm going to go to the financial outlook on Slide 13. So first of all, we have downgraded our FY 2021 revenue guidance from $1.8 billion to $1.65 billion. That is based on an assumption of $0.77. The decline was driven by about $70 million of FX, about $22 million of lower U.S.A. support revenue and some COVID delays in Australasia that are pushing some progress out of FY '21 and into '22. But a good news there is that we have been able to maintain full year EBIT guidance of $125 million, also down at $0.77. Of course, we've faced FX headwinds, but that's been offset by the margin improvement on the U.S.A. shipbuilding and also the benefit of the pickup in U.S.A. support that was attributed to the second half of FY 2020. To give you a sense of FX sensitivity, a $0.01 movement in the FX rate for the second half would have approximately $600,000 impact on second half EBIT. At this point in the year, we are not going to provide guidance on FY '22, but we did want to give you a sense of the baseline level of revenue upon which we can build. So we see $1.4 billion of revenue for FY '22 as a baseline, which includes contracted ships, EPF 15, which is appropriated by Congress, but has not been awarded to Austal yet, and assumption of support revenue continuing at the first half '21 run rate. And we would see additional contracts in the shipbuilding space that could be progressed in FY '22 as being additive to this number. I'm now going to hand back to Paddy to go through further outlook details.

So if we move on to the half year outlook and life beyond LCS, I think the biggest question we all have is, what comes after LCS? I've put this slide together because I wanted to demonstrate the volume of opportunity that we see out there. And it is significant, and it comes in shipbuilding and it comes in sustainment. I still believe that the U.S. giving us the $50 million match funding to get our yard in Mobile still capable is still the strongest indication I have that we're very much part of the U.S. industrial base. And we are very much required for them to achieve the naval program that the U.S. needs. There are numerous major steel shipbuilding programs on this slide and what we've listed are the ones perfectly in our size range. So if we think about the LAW program, very exciting. We think about OPC, which is in play at the minute, very exciting. And maybe LUSV, but we see some movement in that to the right. And in time, we fully expect FFG second source to come into play, and we are hearing rumblings of that moving to the left, perhaps as early as 2023 rather than the '25, '26 timescales that have been talked about before. We've also listed the opportunities that Greg spoke about to really make sure we are embedded as a prime contractor in U.S. sustainment with the SEC East and West running admissions contracts. Hopefully, within the next month, we will have some news on SEC East. And June, July time, we will have some news on SEC West. As the business has grown from shipbuilding and sustainment, we see it very important that we are a major player at the top level in sustainment going forward. We also see a lot of opportunities with the EPF ships. So EPF 15 appropriated, and we expect contract awards imminently. And EPF is very interesting because we're starting to see modifications coming through, whether it's hospital capability, small boat handling, capability improvements, the ability to land Osprey on it. And I think it's also really important to note that $50 million that has been appropriated to make the vessel autonomous. And that should be awarded in the very near future as well. The importance of that for me is it's something that is here and now and something that Austal can do, and we'll be able to demonstrate. and it's something we will certainly be pushing ahead of the LUSV concept, and that could be a good route for Austal to secure future in autonomy. And we're also starting to look much longer term. So things like the next-generation logistics chip. while that's sort of concept at the minute, I put it up there because we want to start looking further into the future, planning our programs and making sure we're not in the same situation we find ourselves in today, that we're really fighting hard to get work in the near-term to secure the revenues going forward. So I think, in summary, there is an awful lot of opportunity out there. We're very optimistic about it. We're very well placed to go and win it. The shipyard is performing exceptionally well, as you can see from these set of results. Steel conversion is underway, and remember that Navy have driven us very hard to make sure that, that is ready for May 2022, which I think is another strong indication that there are plans behind the scenes that we are very much part of the industrial base. So I would love to be sitting here today telling you that I had a steel contract to announce, but we're working very hard towards being able to do that, whether it's a full contract or whether it's something like modules that would allow us to demonstrate that we are steel ready, steel capable and can do it. More to come on this and is very much the focus of the business. So if we go on to Slide 15, the strategic outlook. This is the last slide I plan to present before we open for questions. But I think we've got to take it on the chin that LCS transition and COVID impact are very big and real issues for us. But I think we've demonstrated despite that, these are a great set of results with a very strong operational performance. And these are challenges I think we are well placed to overcome. The balance sheet has really helped us during COVID, allowing us to invest for what looks like a really exciting future and invest well. And those investments and transitions of people and businesses have executed exactly as planned. We're a much more diverse business now, operating in shipbuilding, support and indeed systems, and we will talk more about systems in the future and how we're investing to make our business more efficient and our products more attractive to people in the future. I think the same macro factors driving the U.S. Navy are also apparent in Australia. As we've seen with the award of the 6 tech vessels and also looking forward to the clearly defined construction runway for a whole host of new vessels through Australia's outlined force structure plan and of course, the sustainment opportunities that follow. We see some challenges, of course, in the commercial world, but there are some very interesting opportunities out there. And I put the Spirit of Tasmania on this slide because you may have seen some press that we are working with the Tasmanian government to help increase the Australian content of that vessel and find a way to build that in Australia, and that would be a very significant contract for a whole lot of reasons. It's a big contract. It would be working with the European supplier. It would give us an opportunity to bring together a steel hull and the efficiency gained through an aluminium superstructure. So all the skills that Austal has and being able to bring work to Australia, supporting the government with their desire for continuous naval shipbuilding and sovereign capability in shipbuilding. In terms of systems and strategy going forward, we're making quite significant investments in digitization of our shipyard and the efficiencies that come with that. And with the strength of the balance sheet, I'm pleased to say we're continuing to invest in research and development and the technology associated with our business and ships. I think in summary, of course, we need to generate new contracts for the future, but I'm very confident the future is bright because we've demonstrated we can deliver operationally. We have the capability to deliver in steel and aluminium, in shipbuilding and support, in commercial and defense, and there are a whole lot of opportunities out there for us to go and win. So at this time, I would like to open the call to questions and hand over to the operator to guide us through that.

[Operator Instructions] Your first question comes from Alex Karpos with Goldman Sachs.

Just a couple on my end. First of all, on the U.S.A. President change, I guess, why now? And do you anticipate any disruptions to the business? Or anything we should be aware of as far as kind of near-term impacts?

So good question. We concluded our internal investigation on Monday. And on the back of that, we chose to accept the resignation of Craig. As you're aware, the CFO, Rusty, has been put in place. And we think Rusty is a great choice for that role because he has been Craig's right-hand man. He is all over contracts. He is all over the finances, obviously. And the work we're doing in the mergers and acquisitions space to help secure the future. As you'll also be aware, we've reported our findings to the Department of Justice, and we've been completely open and transparent to try and demonstrate that we have resolved these problems. We're happy to work with them, and we very much want to be part of the future of shipbuilding in the U.S. I think finally, the most important thing financially is we've also confirmed that the write-back we did in 2016 is the correct number. And we don't believe there's any more bad news to come through the finances.

And maybe if I could just ask about the kind of project timing this year. Roughly fine, but how should we think about award windows for the unmanned program, LAW? And some of the newer ones like the next-generation logistics ship?

So next-generation logistics ship is a long way off. That's in concept. But things like OPC are in play now and something that we are actively tendering. Very exciting contracts, potentially $400 million of vessel. It is a program of work. So we would anticipate 10-plus vessels. We have received the request for proposal, and we're due to submit that in May of this year. We would expect awards middle of 2022. So it's very interesting because it times very well with whenever we will be still capable. Obviously, a difficult contract to win because there is an incumbent. But perhaps performance on the incumbent, not quite as expected, and we think we will be very competitive in our tender with the efficiencies we've demonstrated on other programs.

And maybe unmanned and LAW as well.

So unmanned, it's hard to get a read on at the minute. There seems to be new news every day about what exactly they're looking for, and therefore, what the timescales are. The size of the vessel seems to move and is shrinking rather than growing at the minute. We would have preferred a bigger vessel. But I think autonomous EPF is a real opportunity for us, as I stated earlier. That's something that we're likely to put on EPF 13 and getting something out there that demonstrates capability for autonomy in a large-sized vessel and maybe something that causes them to think about whether they need LUSV as well as an autonomous EPF. Light amphibious, again, we're anticipating approximately $100 million a ship, 28 to 30 ships. Steel construction, so absolutely right for us. Hopefully, in the 2023 time period for the start of build. So again, if I'm optimistic and I look at what Navy have asked us to do in terms of being steel-ready in the middle of '22, this is another program that would fit very nicely with the skill set and the facilities that we have.

Your next question comes from Russell Gill with JPMorgan.

Just a follow-on question on some of these award programs. With the OPC and the LAW project, obviously, the OPC, you wouldn't be using your own design. And what about the LAWs project? Would you have the design a lot more? Or are you essentially just going to be operating as a subcontractor is where you're thinking of positioning the business?

So OPC is certainly someone else's design. LAW, we would very much like to get involved in the design of that vessel and how we tailor it for the needs of the Navy and the facilities we've got on our capabilities.

So Russ, so just one additional point. Even using someone else's design does not necessarily mandate being a subcontractor. You can be a prime contractor to someone else's design.

Sure, I get it. But the IP on the design of the OPC is the incumbent rather than effectively you guys, right?

Yes.

Yes. Just if we talk through the U.S. margins, obviously, they're quite impressive, particularly given you called out revenue, I guess, delay. Because COVID-related revenue delays. The LCS 26 incentives, are you expecting similar incentive-type payments from the delivery of 28 onwards in the sense of you're sort of outperforming expecting incentive payments to be a similar sort of magnitude going forward?

There are incentives on offer for remaining LCS.

And are you currently tracking in line with received digits?

Sorry, I missed the word you used, Russell.

Are you tracking in line to receive a similar amount of incentives as what you received to LCS 26?

There's similar amounts by ship, but the timing is mismatched because they're based on different milestones. So according to how many milestones fall into a given half or a given year will influence whether that goes up or down.

I guess another LCS question. The fact that there may have been some delays on delivery because of COVID-related restrictions and the like, does that impact your ability to receive the incentive? Or is the negotiation, the government is knowing that, that was kind of an impact to your operations?

The U.S. Navy has provided some relief on COVID. I can't speak to the individual assessment ship by ship about whether they would provide relief on a launch date or a delivery date tied back to COVID. But they are the arbiter of good taste when it comes to awarding incentives.

And in your accounts, you've got some contingencies around 2 vessels that missed delivery dates. And there's progressing risk that the counterparty doesn't accept the vessel and asks for their cash back. Was there no insurance -- I mean can you get insurance on these vessels? I mean it appears from the way that you've taken this contingency that you see it as very, very low risk. But there's no business disruption insurance or the life on these 2 vessels because the size is quite meaningful?

Yes. I'm not aware of any insurance you can get for these vessels. It's a feature in the contract called a long stop date. And it's put in there as a date by which there is a chance the operator will no longer have a business requirement for the vessel if it has not been delivered. And we've never seen anything like COVID before, so we have never had any major concern about these dates because they are set usually so far after the expected delivery date. And they're not something that give us any cause for concern. The first vessel we talk about is the Fjord Line vessel in the Philippines, and that was about to start trials just as COVID hit and the Philippines went into full lockdown. I'm pleased to say that last night, we achieved technical acceptance of that vessel, and that puts us on track for full acceptance of the vessel later on today. And that vessel will leave the Philippines and set sail for Denmark sometime next week. So we have worked through it. And we're also working through the Mols vessel, which is the follow-on vessel in the Philippines with the customer. We're still confident that they require the vessel because it's a government-funded route, and they have a requirement to put new tonnage on that route. And we don't believe there's any other way they can do that without this vessel. So I think that's why we've put them through the accounts as a low-risk, but we've tried to be as honest as possible with exactly where we stand contractually.

Your next question comes from Mitch Sonogan with Macquarie.

Paddy and Greg, just a few quick ones from me. Just thinking about that $1.4 billion FY '22 baseline revenue guidance, can you maybe just give us a little bit more detail on how it's split across U.S.A. and Australasia? And also, I guess, just thinking about the support revenues. Is the latest half sort of a baseline that we should assume going forward, and your lines on those East and West sustainment programs with the LCS to build from here?

Yes. So there are numerous elements of that, Mitchell. First of all, the '22 isn't guidance, it's a baseline level of revenue given the contracted work, a level of confidence that EPF 15 is going to be awarded to Austal, having already been appropriated by Congress. I'll tie it into your comment there about support. It does assume the first half level of support as a run rate. but we're using that as a baseline. When we use the word baseline, naturally, we're not trying to make that a bull case. I'm just trying to give you a platform to think from. The order book for U.S.A. extends out through to LCS 38 being delivered in FY '24. So it's fair to say that a big chunk of the revenue in the $1.4 billion is associated with the U.S. business. And then we've got the commercial ferries with Fjord Line, Fred Olsen trimaran #2 and the Mols ferry that Paddy mentioned a moment ago that will feature heavily in on '22. Let me correct that, Fjord Line will not feature in '22, but the other 2 may have some. Then we've got a patrol boat fleet for the Guardian Class as well as the 6 Cape Class Patrol Boats we're building for Royal Australian Navy also featured heavily in FY '22. And the Guardian, the Cape programs go through to FY '23, FY '24 as well. What haven't I touched on, Mitchell, and the various things you asked?

That's fine, Greg. And maybe just following on from Russell's question, probably more about the U.S. shipbuilding margin. Understand there's variations on when you get milestone payments, et cetera. But looking forward, as the LCS winds down into FY '24, how should we think about sort of on an annualized level that margin, is the current one is first half pretty sustainable over the length of that program? Will you expect to see that actually go up? Just some thoughts on that.