Consensus community valuation
Veem yesterday announced Sharrow had formally accepted the performance of the Sharrow by Veem inboard propellers on Veem's test boat. The move opens up the ability for Veem to now start building and selling Sharrow by Veem propellers for customers for inboard applications. They are off to good start with 280 customers already having put down an admittedly nominal (US$100) deposit on the revolutionary design. All of which prompted me to sell my remaining holding here and IRL...wait, what the...?
I might look back on the sale as a failed attempt to play 4D chess, but I need to put my thinking down to remind myself there was some thinking even if it was wrong. Basically, when I sold a portion of my holdings a few weeks ago I did so on two grounds: valuation and on the complexity that was becoming apparent in adapting Sharrow's design to an inboard application. Both of those factors were exacerbated yesterday, with the SP popping and the complexity confirmed.
When Veem originally announced the partnership in October they talked about testing taking place on their boat "in coming weeks", with acceptance implied soon after, sales in early 2024 and the full range offered by the end of 2024. That was probably always optimistic, but I think the timeframes now look wildly heroic. Management more or less conceded the engineering is a lot more complex for inboard motors, with solutions needing to be a lot more bespoke than the generic "one size fits most" approach Sharrow can take with outboard motors. Boat size, weight, propeller shaft angles, vibration and lots of factors I can't even imagine are much bigger issues for the props Veem will be producing, compared to Sharrow.
I'd still back them in to make it a success, but there's going to be a steep learning curve during the first couple of years, while Veem build up a catalogue of what attributes work in particular scenarios. I imagine there is a high likelihood of significant and expensive reworking of props. Further to that, the price of making it a success will be further significant investment required with a new manufacturing site being mooted for Europe or the United States.
My best guess is the next couple of years are a good opportunity to sit on the sidelines, wish them well and hope to get back in later with a better risk/reward tradeoff. The biggest risk I see to this thesis is Defense. I previously mooted that the characteristics of the Sharrow design (particularly quietness) would on face value have great appeal to world navies. Management called this out yesterday with upcoming underwater decibel testing to take place in coming months. If that testing confirms the more subjective and less relevant on deck experience, than it's hard to imagine how you send out a navy not equipped with Sharrow props, which Veem are in the box seat to build. In that scenario Defense are much more likely to fund development. Something to watch.
A nice little announcement by Veem today that Strategic Marine are accelerating the purchase of gyros on their crew boats. Instead of purchasing 12 gyros over three years, they will now purchase all 12 by 30 June 2024.
On the one hand it's not new sales - just accelerated sales, but it's a nice validation of the technology. It's also a welcome cash boost given the likelihood the company will either have to raise capital or increase debt to fund expansion of its propellor manufacturing business and support the Sparrow partnership.
What's a little less certain is what the accelerated sales means for the Strategic Marine exclusivity agreement. Are Veem wholly reliant on Strategic Marine's onsale of gyros in FY25 and FY26? I think I'll ask.
Shares are up 10% today. I'm not sure the announcement below would suggest Veem is now a 10% better business but that's the fun of microcaps.
[Holding]
I've been reflecting on the opportunities and risks associated with Veem's recent signing of a partnership with Sharrow.
A bit of background; Sharrow are a U.S. startup who have designed, patented and commercialised a toroidal propeller design that some (i.e. Sharrow) regard as the biggest single advance in propeller design since the 1830s. The design reduces the significant propeller tip vortices and makes boats equipped with their propellers significantly faster, quieter and - importantly - more fuel efficient. The differences are most prevalent at mid-range rpms but to some extent exist throughout the rev range. Fairly typical review here. A still from the video below shows the relatively dramatic difference.
The advancement Sharrow has made makes them a disrupter and a threat to Veem and other traditional propeller manufacturers. About the only thing that is stopping Sharrow from world domination is the fact they are selling them for five times the price of traditional props. That won't forever be the case. I think Veem management should be congratulated on doing the deal to become the exclusive manufacturer and seller of Sharrow-designed inboard props. It gets them back in the game.
We don't know a few things. Veem will pay a licensing fee on each propeller sold. We don't know how much. I did ask the Managing Director what he expects the gross margin (including licensing fee) to be relative to traditional props. To be honest his answer was a bit rambly, but I think that reflects the fact that they haven't settled on the cost multiple as this will be influenced by the performance they get from an inboard installation on their test boat (they have stated they will report back to the market on this by year end). He did say they wouldn't sell them at the same premium Sharrow is selling outboard props (5x versus traditional prop), but if they work as well as expected on an inboard installation they would sell them at a significant premium to their usual props. In the end he said "margins will certainly increase" - so take that as you will.
We don't know at what point they're going to want to add to their existing capacity. They say they have capacity to build 450-500 props a month. I take that to mean either traditional props or a mix of traditional and Sharrow props, but I've asked for clarification of that i.e. that it's not excess capacity. Assuming it's existing capacity I've asked what the rough excess capacity is - they probably won't tell me but if I don't ask they definitely won't tell me.
Either way they're talking about building a new facility. That adds execution risk and also puts some immediate stress on the balance sheet. The MD suggested an investment of $5-7m would result in a factory that could produce 200-250 props/month. Sharrow is selling their generic props for US$5-12k a pop. Veem props are custom made and typically for bigger boats. Although they only have one operating segment they did disclose propulsion and gyro sales combined as $33m in FY23. Subtract gyro sales of $5m and divide by an average build of 300 props/month (2/3rds of their end of year capacity) and you get an average sale price of around $8k. The MD has said they wouldn't be going with Sharrow's 5x multiple versus traditional props, but let's say it was 2x - $16k/prop. Assuming they build at the lower end of the MDs thumbsuck capacity and you get annual revenue of $38.4m. Is that a good payback? Stunning. But if they're saying $5-7m capex, they probably mean $10m. Plus we don't know the margins they'll make but if you conservatively use the FY23 whole of business margin (63%) it brings annual return back closer to $24.2m (still excellent). But I made so many assumptions in there that I wouldn't trust it to be within cooee of reality. Interesting exercise though.
The other thing we don't know is how they're going to fund it. They already have net debt (manageable but it's there), they're already capital intensive and didn't generate free cash flow last year, and they did a partial sell down during a cap raise a couple of years ago, then soon thereafter disclosed some operational issues, leaving a bad taste in the mouth of some investors. So all that needs to be taken into account.
I think the opportunity is significant. The payback for commercial boats (ferries etc.) in terms of fuel savings is said to be just months. If the takeup of these props on inboard installations replicates Sharrow's experience with outboard props then the MD is saying it won't just be one new factory required but multiple in different parts of the globe. But the risks are also significant and I think that's why the share price hasn't really moved since the announcement. I'm happy to sit on my (under-sized) position for now and see what happens.
They do look cool though.
(updated the maths)
I thought Veem released one of the stronger reports I've seen thus far this reporting season. Both the looking backwards result and the looking forwards 'nuggets' lined up to present a very bullish proposition.
Revenue was 'only' up 10% but improved margins and cost discipline saw them flow most of that into profit (and cashflow).
The Outlook was full of bullish sentiment and light on specifics but a couple of disclosures stood out.
Gyro sales taking off like a frog in a sock was the main reason I had this company on my watchlist but it just never seemed to happen for them. Suddenly with $11m orders on hand and the Strategic Marine exclusivity agreement in place it might be a case of slowly, slowly and then all at once.
As @Wini and others have noted significant focused investment can suppress a company's results for a period of time but for right company the backback in the years following the investment can be significant. The key is finding the company who aren't selling perpetual capex requirements as 'Growth'. Veem are yet to prove that's what they are but I think there's enough in this result to suggest they may well be.
Kicking myself I didn't do more than look at it when the SP dropped below 40 cents just a month ago.
[Took a starter position yesterday IRL. Will look to add in SM]
VEEM came out with their results today and as they'd indicated it was down on FY21, although bear in mind they are still consistently making money and have done so every year since 2014. The CEO opened by saying he was glad to see the back of FY22. I think some of the decline was due to factors beyond their control but some was due to some own goals on their part (the foundry issues in 1H and slowness in responding to cost pressures both appear to be due to flawed processes). Importantly they appear to have learnt from these and have implemented fixes to prevent repeats going forward.
Some notes from the investor call:
General
Impacted by copper price doubling over the past 12 months and freight costs quadrupling. Balance Sheet in good shape (I tend to think it's more ok than good). Employee costs up but hours down, showing impact of wage pressures. Maintained R&D spend and put what they can through EBITDA, which I always prefer to see
Gyros
This is the sexier part of the business with arguably the most potential for growth. However, at the moment the potential isn't being realized, which they state is due to not being able to leave the WA for two years, impacting ability to make sales and repair/maintain units.
Order on hand of $1.3m on 30 June and $2.4m now. They expect this business to run similar gross profit to other parts of the business but have some work to do on at least one of the units. They did say they haven't had to up the price of these units but sourcing parts from different counties. I thought it was interesting they stated they run a 'China-last' procurement policy.
When asked about the opportunity the Damen walk-to-work vehicle would create Mark hinted at some imminent developments around increases in load capacity.
Propulsion
This is one of the largest businesses they run and was up 26% YoY with little sign of that slowing down. Capacity was increased by 25% in FY22 and will be increased by a further 25% later this year. They believe they have the most advanced propulsion facility in the world and are going further ahead, with plans to be able to run 24-hours 'lights off'. Gross profit has returned to usual levels after overcoming foundry issues and passing on price increases.
Defence
This was the big laggard for the year being down 39% YoY, mainly on the back of the end of Austal's littoral ship program for the US. It's a bit opaque what FY23 looks like here. They still have contracted programs going and are tendering for others. I've asked what was included in the FY22 result from the littoral ship program but am yet to get an answer.
Engineering
Probably the less exciting part of the business but it is growing on the back of strong mining conditions and is filling some of the gap from the Defence slowdown. A reasonably bullish outlook but growth will be steady, not parabolic.
Overall
This is a family-owned business that I've liked for a couple of years but never owned. The valuation has felt a bit full to me but at these levels it does feel a bit more of an opportunity. There's a little bit of bitterness that the family sold a part of their holding at $1.18 at the same time as doing a placement at the same price, and then revealed some operational issues in a subsequent update. The update did come a couple of months later and the family still own over 50% of the company, plus a placement at peak SP is when we want the company to do a placement. For me it's more something I'll note rather than put up a big red flag.
The thesis for me is fairly dependent of the Gyro business going big and the evidence of that isn't in...yet. I might have another look after earnings season and see if I can get a bit more comfortable with it after some more work.
@Strawman - maybe one we could meet with in a month or two?
Veem is one I have kept an eye on as I thought they were onto a good thing with their Gyro's, but have not owned previously. I just listened to their conference call and their was palpabel relief that 2022 FY is over. They seemed overjoyed to have come through the other side of the covid impacts in as good of a condition as they have. They also seemed very optimistic for FY23 and how they are a better company for the 2022 experience.
The numbers for 2022 are woeful, but the perfect storm of closed borders, cost increases in freight, material, and labor and manufacturing problems leading to rework all impacted them so even making a 1.4m profit is pretty good all things considering.
- Non-performance issues rectified through a technical group that have improved foundry processes. Highlighted how the company culture is to really fix the root cause of these issues and now non-performance is back to historical lows.
- Freight costs airfright (up 2x) seafreight (up 3x), now working closely with freight operators to forecast where it will be and are adjusting prices every month vs quarterly previously.
- Labor cost being managed Gyro and propulsion largely automated and relies on semi-skilled labor that can be trained in house. Commented that they have the most advanced manufactering facilities for propulsion worldwide and see this as a competitive advantage.
- Engineering relies on highly skilled labor and is a problem but they managing this as best they can in regrds to overtime etc.
- They have moved away from China and have a company policy for China last supply and through this have gotten efficiences in their supply of materials for Gyros. Has enabled them to maintain GP margins without passing price rises as efficincies gained in supply lines.
Propulsion has been a surprise and they have ramped up to respond, demand will be strong out to Fy24 and expect a slow decline from then not a steep drop off. Commented that is still a lot of money out there and demand for superyachts is still very strong. I expect really good numbers from this division in FY23.
Gyros- commented that Covid has really impacted the speed of uptake in this market but they think this year will be back to solid growth in sales. They sold 12 in 2022 but they were smaller units so revenue was lower than 2021. The Damon walk to work boat has been launched and they said they have recieved strong enquiries from this. They have Gyros instock so sales orders can be met quickly if the orders arrive.
Overall they were pretty excited about about he coming year and I think they are starting to look pretty good and I think I will look to buy into Veem over the coming weeks, especially if we get some weakness.