Consensus community valuation
Mixed feelings about today's update. On the plus side they upgraded revenue to $86-88m - not surprising given the previous guidance appeared conservative based on previous disclosures, but still welcome. Also happy to see the opportunity pipeline is also trending up. 'Pipeline' is a bit of a nebulous concept that can mean very little in the wrong hands but I guess $200m imaginary dollars is better than the $175m imaginary dollars they'd previously disclosed.
Less happy about the FY EBITDA guidance of $9 - $10.5 million. This suggests a loss in the second half, although it's hard to reconcile between the unadjusted EBITDA of this disclosure and the underlying EBITDA previously presented. You've got to think that dubiety has a slightly deliberate intent to it. With the Ukraine deal in the rear view mirror the main contributor to 2H was the Australian Army SUAS order, which was always going to be on much lower margins. Possibly even in the teens (that deal I mean, not GM overall), compared to gross margins of over 50% in the previous two halves. But a loss? That's a little disappointing. On a more positive note the awarding of the 5-year maintenance contract for that order is expected to occur in the next quarter. As the equipment supplier you would think XTEK would be in a good position to get it and, if so, it should be on much better margins.
I guess the real unknown is what happens next? I think FY23 may be the highwater mark for revenue for a while. That's ok but how profitable can they be on significantly lower revenue? I still think they're cheap given they're trading around NTA but more work to be done leading up to the FY report.
(Also worth noting they dropped the Purchase Order disclosure given the Ukraine order is complete and the SUAS order in largely done).
[Holding about half of a full position. Was tempted to top up given the opportunity Regal has been giving but will likely wait on the annual report now]
No dollars attached but a promising announcement from XTEK this morning in relation to a partnership with Tata Advanced Systems to (hopefully) supply helmets to the Indian Ministry of Defence (IMOD). Tata Advanced Systems is part of the Tata Group, which is the largest conglomerate in India with almost 1 million employees. A good partner to have if you want to crack the Indian market.
CEO Scott Basham posted a picture on LinkedIn a couple of months ago of an Indian airport boarding gate. He was on a trip back from their new site office in Poland, but the choice to come back via India caused some conjecture, which now makes more sense. Ava Risk (AVA) followers would be familiar with the large IMOD deal they did. Interestingly Scott Basham was the CEO of AVA at the time so presumably has some contacts with/familiarity of IMOD.
[Held as an underweight position]
@Noddy74 thanks for bringing XTEK to my attention with your excellent straws. I wish I had done more research when you first called it out. I thought I’d missed out on its bull run, but the result was fantastic, seemed to be in line with analyst expectations (one only) and the share price dropped 15% this morning. I was prepared with my valuation and bought some. Although, I feel like I must be missing something with the market running in the other direction? Some profit taking perhaps? Can you please help me out here Noddy?
This morning XTEK released its 1H23 results. NPAT up 188% which seemed in line with expectations. Management said they expect FY23 revenue to be over $83 million (funny thing, this statement wasn’t included in the outlook).
Financial Overview
The strong financial performance was achieved by delivering multiple large orders to key defence and law enforcement agency customers in Europe, Australasia, and the United Sates.
The XTEK Group’s revenue from continuing operations increased by 321% from $11.5m (H1 FY22) to a record $48.5m.
Gross Profit margins have increased to 50.6% at H1 FY23 (up from 27.1% at H1 FY22). Net Profit after income tax for the consolidated Group was $6.0m (HY1 FY22 loss $6.8m).
As of 31 December 2022, the Group held cash of $6.9m. The cash balance at the beginning of the reporting period was $36.2m after receiving an advance receipt for an international order delivered during H1 FY23. Cash payments during the reporting period were primarily used to deliver on the major orders on hand and to increase inventory stock. Inventory stock was replenished during the reporting period, with an increase from $16.4m (FY22) to $25.4m, in readiness for the large orders currently under customer evaluation.
“The Group currently expects revenue to exceed $82m for FY23”
There is only 1 analyst covering XTEK in S&P Global data on Simply Wall Street (chart below), however this seems in line with their full year expectations.
XTEK have achieved NPAT of $6 million for 1H23 and it looks like NPAT of $10.5 million for the full year is achievable.
Valuation
A full year NPAT of $10.5 million, 101 million shares outstanding (Commsec), that is 10.4 cps NPAT.
Shareholder equity is c. 35 cps (Commsec data) therefore full year ROE should be c. 30%, up from 16.5% last year and a loss in 2021. XTEK is growing rapidly.
Source: Adapted from Commsec chart
Using McNiven’s StockVal formula and assuming normalised ROE if 24% (allowing for a bit of slowing) equity of 35 cps, no dividends (all earnings reinvested at 24% ROE) and a required rate of return of 15% per year, I get a valuation of 91cps. At a required rate of return of 12% I get a valuation of $1.40.
As Noddy points out, XTEK benefits from conflict, and none of wants global conflict. Unfortunately though this seems to be a tailwind for XTEK at the moment.
Given the business is cyclical, and it’s future is unknown I’m going for a valuation of 91 cps.
Disc: Added IRL this morning.
A very welcome and chunky announcement from XTEK this morning in relation to a new Defence order for aerial drones. Not the highest margin product in their arsenal but it will help absorb fixed costs and the follow on maintenance and support is high margin.
Added to their already stated forecast 1H revenue of at least $47m, this order brings their Technology Division backlog to $35m and so they are now forecasting Group revenue to exceed $82m for FY23. That seems very conservative as it assumes no Ballistics division sales in 2H, which is their biggest growth driver. At the very least they will continue to make retail sales of ballistics armour and so $90m full year revenue looks like the bear case to me (assuming no major delays to delivery) and $100m+ is possible, depending on defence tenders.
[Held]
I thought this morning's announcement was worth posting given I've commented a couple of times in the past week that I wasn't a huge fan of a couple of decisions by the now departing CFO (nice guy though). It can be difficult to assess the impact of a CFO on a business from the outside - when it works best, they're a key contributor to strategic decision making. However, that's not always the case.
I think where they describe the new CFO as having "a proven track record of success in providing advice to boards for decisions relating to M&A, capital development projects, risk management, and financial performance of subsidiary companies" as being indicative of where the board is actively giving their attention.
The experience of the new HighCom CEO is also extremely impressive including being alumni from West Point, Duke University (completing an MBA), Safran University and Stanford Graduate School of Business. Nice to see XTEK are bringing two women into senior roles in a sector that is traditionally dominated by men, in addition to adding Adelaide McDonald as a non-executive director back in August.
[Held]
Let’s face facts – this company benefits from conflicts. That doesn’t mean we want them to happen but the reality we can’t wish them away. Clearly, there’s no shortage at the moment, with the war in Ukraine and Russia’s actions making the rest of Europe anxious. Likewise many analysts are predicting a likelihood China will invade Taiwan in the next five years. The result of that is many countries are vowing to increase the size of their armed forces. Poland is on the record as saying it will increase its defence force from 150,000 to 400,000. Germany is doubling its defence spend. Closer to home Australia will spend $270 billion over the next 10 years and Japan is spending a similar amount over five years.
In addition to that some economists like Russell Napier are flagging defence as one of the few areas that will benefit in what will otherwise be a multi-decade period of muted growth. Putting that together I think you at least have to look at defence given the tailwinds that are present. I guess there’s an argument they could be screened out on an ESG basis, and I’ve no issue with those who do, but doing so won’t prevent conflicts.
It has been a transformational year for XTEK but the rapid growth can make it tricky to analyse the financials. It ended the year with net cash of $35 million, having generated free cash of $23 million. With a market cap below $55 million the multiples look crazy low. However, included in the cashflow was full payment for a large order they received in the year (widely speculated to have been from Ukraine but this hasn’t been confirmed), that was only partly fulfilled. The balance in unearned revenue was around $30 million at year end. For some reason that has been included in Trade Payables. I did speak to the CFO and although he had a reason for showing it this way, it’s not what I would have done and at the very least there should have been better disclosure in the Notes to the financial statements.
Anyway that order has subsequently been fulfilled and thus the $30 million of unearned revenue has now been recognised as revenue in FY23. Costs to fulfill the order would also have been incurred in FY23. Again it’s not easy to estimate those costs given the substantial increase in gross margin percentage in FY22 but let’s assume that those costs represent half of the revenue, it brings net cash down to about $20 million ($35m disclosed minus half the value of unearned income of $30m).
The beef I've always had with defence industry suplliers (and other small gadget companies generally) is too often insiders always seem to let the possible get in the way of the profitable. I get it too – the tech is cool, the gizmos are amazing, the temptation to push boundaries and pursue moonshot projects is hugely tempting…and wallet draining. When I look at the history of XTEK that’s what I see; decades of largely loss-making years, dilutive acquisitions, constant cap raises, letters from the longtime Chairman expressing remorse for yet another disappointing year. But when I look at XTEK today I see something a little different…I see at least the possibility of a company that has new leadership, has cut away the fat, has a very clear strategy going forwards, has the infrastructure to deliver it and finally has tailwinds behind it.
What does XTEK do?
Historically XTEK had a finger in a lot of pies. It made ballistic armour, various parts for rifles, spacecraft, built aerial drones and ground robots and sold software to enable real time aerial mapping.
In the past year or two it has slimmed its focus, ceased producing lethal products (i.e. gun parts), stopped talking about building bits of satellites and lined up under just two divisions. The Ballistics division manufactures and sells body armour, rigs and helmets and the Technology division builds and sells surveillance drones and mapping software. As you would expect the customers for both divisions are generally DoDs or state/municipal authorities. The ballistics division also sells to retailers.
Ballistics looks like being the main focus going forwards. In FY21 Ballistics accounted for $16 million of the $28 million XTEK earned. In FY22 Ballistics grew exponentially to $47 million of XTEK's total of $58 million. Based on the backlog and pipeline it looks likely Ballistics will continue to earn the lion’s share in FY23, notwithstanding the CEO has flagged a possible doubling of the Technology business this year. You could ask why they don’t just focus on Ballistics and sell/exit Technology altogether. When asked they state the Technology business is an excellent lead generator for the Ballistics business.
XTEK is headquartered in Canberra but manufactures at two sites, Adelaide and Columbus in the US. The CEO likens the Adelaide site to a Ferrari factory. It houses their proprietary equipment XTclave, which is essentially a vat of oil, which uses heat and extreme pressure to mold high end ballistic armour and helmets. Whereas much of the armour and helmets you see on TV are pistol-resistant, they claim you could be shot in the head by a rifle at point blank range and wearing their products require nothing more than a Panadol – a claim I haven’t tested (but the National Institute of Justice do so it’s all good). XTclave enables more complex shapes to be molded, which is useful for helmets and female body armour.
If Adelaide is a Ferrari factory, Columbus is the Datsun Sunny 180B factory. It’s the base for the Highcom business they acquired a couple of years back and is where they produce high volume armour, selling to armed forces, government agencies and retail distributors. In the past the majority of their product was produced on an agency basis and so would leave the factory with someone else’s label on it, but part of their new strategy is to push the Highcom brand, avoid the middle man and maximise margins. They appear to be getting some good traction in this and based on product reviews look like being a trusted player in supplying the armour needs of your whole family!
Or how about this one:
I can’t say I’ve ever thought about buying ballistic armour for my family – I guess Americans love their kids more than we do.