Upgraded to SPEC BUY from HOLD

Austal was holding up well through the historic storm of 2022, anchoring our portfolio safely; and then was cast adrift by cost concerns relating to a contract with the US Navy for ASB’s new steel shipbuilding facility in Alabama.It is ASB’s first steel related contract and is initially for two towing and salvage ships, with an option for four. The total contract value is US$385m for fivevessels, but some cost inflation, as well as expanded specifications and material requirements from the US Navy customer have increased construction costs. This contract is forecast to lose US$41m; but this amount could be eliminated if ASB secures requests for equitable adjustments from the US Navy. ASB fell 10% on this news, which came close to the end of the day.News that ASB is working on component parts for aircraft carriers, training to build command modules in nuclear submarines, developing autonomous vessels of various sizes, emergency medical ship development, was overlooked. With increasing cooperation between the US and Australia, the company is well positioned to benefit from these relationships, as well as to contribute to new technological advancements in military ocean vessel building over the medium-term.This is not the first cost overrun on a shipbuilding project and it will not be the last. These can be exceptionally complex manufacturing challenges; the process of quoting and estimating costs has risks.ASB may have underestimated the complexities of the transition from aluminium to steel building, but most importantly, there is no evidence of any critical difficulties with the steel process. A risk to the stock is the US Congress putting constraints on defence spending, but in the end the US needs will get built.

RADAR RATING SPEC BUY  (UPGRADE FROM HOLD) ASX CODE ASB
CURRENT PRICE $1.73
MARKET CAP $625M
DIVIDEND YIELD 4.6%*NET CASH $124M RADAR RATING: SPEC BUY (Upgrade from hold)

Although a new Offshore Patrol Cutter award fromUS Coast Guard has been challenged, it gave investors confidence. Cost overruns on an existing US Navy contracts have created some uncertainty, but investors will hope that these can be largely recouped.