Now that the U.S. Navy has decided on a new name for its joint high-speed vessels, it's time to start building them -- and for military shipbuilder Austal USA, to start profiting from them.
Last year, we made quick mention of the Navy's new designation for its JHSV class of vessels -- now called Expeditionary Fast Transports (but confoundingly abbreviated EPF). Designed as hulking catamaran "tin cans," with a thin aluminum shell wrapped around four powerful engines, and perched atop two runners, these vessels offer the Navy the ability to move simply massive numbers of troops and supplies at very high speeds, and at an affordable cost to boot.
And now the Navy is building more of them.
Austal shifts into high gear
As of the end of last year, the Navy had acquired about a half dozen EPFs for the Military Sealift Command. More are on the way, however, and soon. We know this because last week, in its daily digest of contracts awarded, the Pentagon announced that it has hired Australian shipbuilder Austal (AUTLY) to produce two more EPFs, which will be Nos. 11 and 12 out of an anticipated purchase of 22 ships total.
According to the Pentagon, Austal will be paid $248.9 million for its services -- a fixed-price award that implies EPF prices have already dropped well below their expected purchase cost of $160 million each, to less than $125 million.
What it means to Austal
The contract isn't coming a moment too soon. Just last month, Austal announced its financial results for full-year 2016, and the news wasn't good. For the year, the Australian defense contractor posted $63 million in losses, largely due to cost overruns in its program building littoral combat ships...also for the U.S. Navy. (Austal competes with Lockheed Martin (LMT 2.59%) in the production of littoral combat ships for the Navy -- but unlike Austal, Lockheed appears to be making a profit off of them.)
Lamented Austal: The "costs of implementing design modifications across the LCS program to meet the US Naval Vessel Rules" were directly responsible for the company's losses. At the same time, CEO David Singleton expressed hope that Austal's "strong order book and ... strong cash flows" would return the company to fiscal health in short order.
What it means to investors
Just how strong is Austal's order book, though? And how strong its cash flows? And do these two factors add up to making Austal a winning investment?
According to the company's financials, as related by S&P Global Market Intelligence, Austal did indeed post a big loss last year -- its first such loss since 2003. But the company is not without hope, nor the stock without its attractions. As Singleton alluded, cash production at Austal is very strong indeed, with free cash flow reaching $45.5 million last year. Weighed against the company's $403 million market capitalization, and adjusted for its $39 million net cash balance, the stock sells for an enterprise value of just eight times free cash flow today.
I consider this a very fair price to pay for the 9% long-term growth rate that analysts have assigned Austal. And with Austal confirming that it has $2.6 billion worth of backlogged work in its order book -- more than three times trailing sales -- I see no reason the company cannot achieve that growth rate.
In fact, when you factor in the stock's 2.7% dividend yield, I'd even go so far as to call Austal stock cheap. The stock sells for just 0.4 times annual sales -- less than a third the valuation on Lockheed Martin stock, and well below the defense industry valuation rule of thumb of 1 times sales equaling fair value.
Put it all together, and I see a very strong case for buying Austal stock today.