Should you buy Austal Limited shares at today’s prices?

Credit: Naval Surface Warriors

Shipbuilder Austal Limited (ASX: ASB) has been a strong performer in recent times as investors have hitched their wagons to the company’s growth and US dollar earnings, which translate favourably into the Australian dollars the company reports in.

Up 77% in the past 12 months, or just 3% in the past five years – is there any value in Austal at today’s prices?

A $3.1 billion order book

Austal touts its $3.1 billion order book –with orders out to 2020 – as a strong sign of the company’s future.

A significant portion of these vessels are already complete, however, and with $1.4 billion in revenue earned in the past year, the company will be relying on future contract wins to maintain or grow its earnings between now and 2020.

An opaque outlook on demand

It’s difficult to evaluate the number or type of orders which may come in from major defence or commercial customers in the near future. Readers might think that with all the unfortunate events happening in the world, there will be growing demand for defence vessels.

This may be so, but it is difficult to establish a link between the two and it is not reliable as an investment thesis. On the other hand, Austal is building on its capability to deliver commercial vessels and this should stand the company in good stead for the future.

A low-margin business

Profit margins appear sustainable, although they are quite slim. Austal prefers to use Earnings Before Interest and Tax (EBIT) margins, which were 5.2% in Financial Year 2015, down from 5.8% the previous year.

Austal expects to deliver incremental margin improvements in its main business line – the Littoral Combat Ship (LCS) – over the coming years, and recently refinanced debt (at lower rates) is expected to make a modest contribution.

Decent cash flow

Austal managed to deliver positive Free Cash Flow in 2015, i.e., there was money left over after the company reinvested into the business. This is a good sign and a feat that larger companies don’t always achieve. Additionally the company is paying down US$100 million in debt and expects to post a ‘net cash’ position (total cash being greater than total debt) in the current financial year.

A few quick metrics

Austal trades on a Price to Earnings (P/E) ratio of 16, which is broadly in line with the average of the S&P/ASX 300 (INDEXASX: XKO) index. A dividend yield of around 1.6%, fully-franked, is slim but appears highly sustainable given that it represents just 7% of the company’s Net Profit After Tax (NPAT). As an interesting aside, fund manager Allan Gray Australia recently reduced its share from 16.42% to 15.4% of Austal.

So, should you buy Austal?

Austal is a decent company and has a solid financial position. However, I would not buy shares at today’s prices as I believe the company is fully valued, and upside from here depends on future contract wins and margin improvement.

For my money, there are better investments available.

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Motley Fool contributor Sean O'Neill doesn't own shares in any company mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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