A sinking ship? Citi downgrades Austal’s price target by -45%

International banking giant Citi downgraded its price target for ASX-listed shipbuilder and defence stock Austal (ASX:ASB) on Tuesday from $3.70 to a new target of $2.32, a decrease of -45%. 

The downgrade comes on the back of Austal’s latest earnings update published last Tuesday which saw the shipbuilder estimate FY23 earnings of $58m, down from a previously forecast $100m.

That downgrade reflects a $42m loss, a- 53% decline.

Since that update was published last Tuesday, one week returns for Austal are down -13.6%.  

Still room for upside 

However, with the closing price on Monday 23 January 2023 being $1.74, Citi is still bullish on Austal. 

The target price of $2.32 still suggests a total return of 37.9%, a healthy figure unlikely to be scoffed at. 

“The T-ATS-related downgrade is disappointing, and a reminder of the risks involved when a new vessel build commences,” Citi Research wrote.

“The implications on Austal’s prospects to win the more complicated T-AGOS construction contract (which has been delayed to CY23) remain unclear.”

So what gives with the downgrade?

Austal’s expected $42m loss in question relates to a 2021 US Navy contract valued at US$198m which the company won to build two Towing Salvage and Rescue Ships (T-ATS 11 and 12). 

One point of possible uncertainty: Austal cited an earnings downgrade to “AU$58 million” from A$100m in Australian dollars, a loss of A$42m, but also references a loss of US$41.2m in its latest earnings update. 

Two big ships and big troubles 

Two years on from the contract’s execution, a revised forecast of costs for the 2021 shipbuilding program has left Austal admitting it will cop a US$41.2m (A$58m) loss from the contracts. 

This comes after The Australian Securities and Investments Commission (ASIC) took Austal to the Federal Court in June 2021 over the contract, given that Austal failed to disclose to investors it was going to make a loss on the contract.

Austal landed in hot water even earlier in 2018 when it failed to disclose to shareholders the outcome of an Australian Tax Office (ATO) assessment which challenged the rosier outcomes of an Ernst & Young audit. 

Why even take the contract? 

Presumably, Austal’s management team perceived the relationship value of the contract with the world’s largest navy forces to be of greater interest to the company than material gains. 

Austal notes it has applied to the US Navy for a Request for Equitable Adjustment (REA) but does not foresee a decision on this outcome being reached before the end of FY23. 

Should those REAs be accepted, the company expects its losses to be lessened. 

Perhaps a more interesting question to unsympathetic readers (or reporters) is why the US Navy keeps giving Austal contracts in the first place. 

Quality issues haunt buoyant reputation 

This is because Austal is no stranger to controversy on the manufacturing floor, either. 

A 2022 report from Maritime Executive alleges the Independence class Littoral Combat Ship (LCS), Austal’s premier combat vessel for the US Navy, had cracked hulls in nearly half of the existing fleet. 

Last year, the US Navy decommissioned Austal’s USS Coronado (LCS-4) after less than a decade. The ship once spontaneously caught fire on the ocean in 2013.

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