Small Caps | May 24 2013
– Composite demand on the rise
– Quickstep offers superior technology
– Jet fighter contract still in play
By Greg Peel
Back in 2009, the new US president decided the budget deficit needed to be addressed and as part of that process cancelled the production of further expensive F-22 stealth jet fighters for the defence force, preferring to commission Lockheed Martin’s more conventional, less costly, but no less modern F-35 joint strike fighter. The US order at that stage was for 3000 JSFs but pre-orders were also made by US allies, including 100 earmarked for Australia.
The skin and other components of a JSF were intended to be constructed not of steel or aluminium, but of composite material. Composites include fibreglass, Kevlar and carbon fibre mixed with polyester or epoxy resins, for example, which boast much higher strength-for-weight ratios than metals. The downside is that while metals are readily shaped and welded, composite parts need to be moulded using high pressure and high temperature vacuum autoclaves. The process is technologically complex, and expensive until economies of scale are introduced.
Up until recently, the use of composite materials has been limited to the realms of formula one racers or high-cost supercars, Sydney-to-Hobart yachts and so forth, as well as in defence and high-tech applications. Last decade brought composites more into commercial focus, due to rising metal prices on the one hand and a burgeoning “green” push on the other. Light weight means lower fuel consumption, hence today’s new hybrid and electric cars and new airliners such as the Airbus A380 and Boeing 787 Dreamliner exploit composite components. Later this year BMW will release its new i3 and i8 models which will become the first mass-produced composite vehicles.
Despite composite materials having been around for decades, when Lockheed Martin came to sign up manufacturing contractors for its composite components it was forced to travel far and wide to find companies with the right capabilities in the complex composite space. The company found itself in Fremantle, Western Australia, where it tacitly signed up small Australian manufacturer Quickstep Holdings ((QHL)). Not unsurprisingly, Quickstep was located in one of Australia’s well known yachting centres, yet the company had already drawn interest from the likes of Airbus and Boeing due to its own proprietary Resin Spray Transmission (RST) technology. (See: Quickstep Has The Right Stuff, from 2009).
On news of the Lockheed deal, QHL shares jumped to over 60c from under 20c in the space of six months. But alas, in the ensuing period the US government became ever more obsessed about government spending, the development path has hit some turbulence, and the whole JSF program has been under a cloud. The Australian government, too, has become obsessed with spending cuts and defence has not been immune. The future of the JSF program has wallowed in uncertainty in the interim, and QHL’s share price has quietly drifted back to today’s 15c.
The market may have lost interest in JSFs, and composites, and Quickstep, but Quickstep did not lose interest in further developing its technologies and preparing for what is expected to be a boom in composite use in construction, particularly in auto and aerospace, in the years to come. The bad news may have been that the extent of the JSF contract had become less certain, but Quickstep was nevertheless able to secure government grants not just in Australia, but also in the US and Germany. The good news is Quickstep has not wasted its opportunities, such that the JSF is now only one contract among many that should ultimately cement the company as a globally respected composites manufacturer.
State One Stockbroking has been following Quickstep for some time and has long held a positive view on the stock given its upside potential, while acknowledging shorter term development risk. State One believes a major shift to the use of lighter weight composites in the global auto industry will be driven by legislated efficiency and pollution targets for vehicles in leading economies. Use in the aerospace sector will continue to trend upward, with airlines not needing legislation to encourage lower fuel consumption, but the broker suggests auto demand will prove the primary driver of Quickstep’s potential.
Manchester University forecasts demand for carbon fibre production will increase from 53ktpa in 2012 globally to 220-340ktpa by 2020 and 1500-1800ktpa by 2023. State One expects such a demand increase to ultimately impact on metal prices, including steel. Quickstep’s proprietary processes offer “substantial” advantages, suggests State One, over existing autoclave and other composite technologies.
The company is nearing completion of a new world class aerospace factory at Bankstown in Sydney, which is set to service auto applications as well as commercial and military aircraft contracts. The factory will have the capacity to manufacture upward of $100mpa of composite panels and the company has to date secured aerospace contracts in excess of $800m, with further contracts under negotiation. Traditional autoclave services currently provide Quickstep with a modest income, but it is the company’s high-tech proprietary processes that will take Quickstep into blue sky. The company is expected to become cashflow positive by late next year. State One is forecasting sales revenue to increase from $500,000 in FY12 to $178m by FY20. Bankstown is expected to hit full capacity in FY15.
Contracts signed to date include a deal with helicopter manufacturer Sikorsky. Quickstep has beefed up its technical support network, with offices in the US, Germany and Geelong, Victoria. State One believes the company is presently in discussion with eight different Original Equipment Manufacturers, with part runs of 1000-2000 expected to flow once the RST facility at Bankstown is up and running. The good news is that Quickstep’s major capex outlays have run down as contract commitments have run up, meaning the company can expand without dilutionary equity raisings. Quickstep has also received grants from the Australian, US and German governments.
Back to the JSF. It was this potential contract which put Quickstep on the radar in the first place.
Less than a year after opening the Bankstown facility, Quickstep has produced the first bismaleimide and graphite epoxy parts for JSF contractor Northrup Grumman and proven, on a test basis, the facility is equipped and qualified to execute required processes for the JSF program, which include fuselage and other part manufacture. So pleased was Northrup that the company last week issued a press statement to say how pleased it was. Additional parts will be produced under direct contract to Lockheed Martin.
The US government is expected to order 60 JSFs very shortly. As to just how many the US will ultimately commission remains unknown, and aside from US budget issues there have been some delays on the design front, as is usually the case with high-tech aircraft. The next orders are then expected from Singapore and South Korea, and Japan has already stuck its hand up. Israel, Norway and the Netherlands have also reaffirmed support for the project. Australia still intends to order 100 planes to replace the Vietnam era F111s.
The JSF contract is not dead, and nor is Quickstep a one-trick pony. Unfortunately, on a share price basis, QHL’s fate has been inexorably linked to the JSF and media flow on the aircraft’s troubled development. State One believes the JSF will ultimately be successful, despite a lot of scare-mongering in Australia and elsewhere. Moreover, Quickstep’s future is not “overly dependent” on the JSF, State One exclaims.
As noted, QHL is currently trading around the 15c mark. Applying a 10% discount rate out to FY20 and a PE multiple of 12 times, State One derives a net present value of 46c. A PE of 20x would suggest 75c. Such valuations are very conservative, and State One notes that “it is possible to derive much higher valuations, but the lower end of the indicated range is virtually assured”.
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