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Austal shares surge

Ship builder Austal Limited (ASX: ASB) has seen its share rise by 13% today, after the company announced that it will build two Littoral Combat Ships (LCS) for the US Navy.

Austal has already built four out of a 10 vessel contract awarded in 2010. The contract to build the fifth and sixth ships is estimated to be worth around US$680 million. All up, the 10 ship program is potentially worth over US$3.5 billion.

Austal CEO Andrew Bellamy said that the company’s US Navy programs provide revenue and workload for years to come. Austal also has another US Navy contract to build 10 Joint High Speed Vessels (JHSV), valued at around US$1.6 billion, with one delivered and another nine to be built.

Sounds great doesn’t it?

Unfortunately, the problem for investors is that despite its large revenues, Austal has very low margins of around 2.5%, and is heavily reliant on the US Navy for survival. Depressed global conditions means demand for large commercial vessels is soft, and apart from a $330 million contract to design, construct and support eight Cape Class patrol boats for the Australian Navy, the company struggles to gain sales in other regions.

Long term debt has ballooned as the company invests in property plant and equipment that is required to build ships, and total debt now stands at around $265 million. Additionally, the company was forced to raise $86 million in new equity capital in November 2012, as it attempts to reduce debt down to $130 million.

Showing how poor Austal’s financials are, net income is forecast to come in between $23 to $26 million in the 2013 financial year, around what it earned in 1999, despite revenues tripling. Earnings per share will be much less than 14 years ago, thanks to the most recent capital raising.

Free cash flow over the past decade has been negative, despite the company reporting $246 million of profits over the same period, showing how important it is for investors to check the cash flow statements, illustrating that “cash is king”.

Foolish takeaway

Despite the recent contract wins (which were part of a program already announced), Foolish investors would be wise to give Austal a miss. The risk of the company disappointing shareholders in future appears to be high.

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The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned.

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