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This report is published for educational purposes                                                                           Curtin University Student Research
          only by student competing in the CFA Institute
          Research Challenge                                                                                                                          Industrial Sector, Shipbuilding Industry
                                                                                                                                                        Australian Stock Exchange (ASB: ASX)
                                                                                                                                                                Austal Shipping Limited
   Date: 21-Oct-2016                                                                                    Closing Price: $1.54                       Recommendation: BUY (26.6% total return)
   Ticker: ASB AU                                                                                   Headquarters: Henderson, WA                                         Target Price: $1.95

                                                                                             Austal: Becoming Australian’s Global Shipbuilder
                                           Market Profile
                                                                                             We issue a strong BUY recommendation for Austal Limited (ASB) based on a one-year target
                     Closing Price                               $1.54                       price of $1.95 through analysis using Discounted Cash Flow to Firm and Relative Valuations
                     52-week                                                                 methods. This offers a 26.6% upside from the $1.54 closing price on October 21, 2016. Our
                                                           $2.56 / $0.94
                     High / Low                                                              recommendation is driven by:
                     Market Cap                           $522.6 million
                     Insider Holdings                            9.41%                       Growth Strategy – Austal has historically relied on order book growth by securing lucrative
                     Institutional                                                           contracts to increase its value. This has been a successful strategy, and has seen ASB become
                                                                40.65%
                     Holdings                                                                a player in the large international market of American defence. The latest growth strategy
                     Dividend Yield                              3.81%                       brings that experience home to Australia, by becoming the preferred contractor of projects
                     Beta                                         1.3                        for Australian Royal Navy, and capitalising on the high margins of post-construction support
                     P/E                                         -6.2                        works.
                     EV/Revenue                                  0.35
                     EV/EBITDA                                   -5.13                       Valuation – A combination of discounted cash flow to firm (DCF) and relative valuation
                     Target Price                                $1.95                       models were used to establish a one-year target price of $1.95 per share. Perpetuity growth
   Source: Bloomberg                                                                         and terminal EBIT multiples were considered for the DCF. Price to earnings, price to book
                                                                                             and EV/EBITDA multiples were considered in the comparable company analysis. Each of the
                                                                                             five multiples were weighted equally to establish the $1.95 target price
                                        Figure 1: Valuation
                                                                                             Substantial Risks – The primary concern facing Austal is contract risk stemming from the
                                   DCF                                                       nature of defence work, which is dependent favourable budget allocation. Uncertainty
                                                                           $2.04
                                Perpetuity                                                   regarding global economic growth, foreign exchange movements and operating margins are
                                DCF EBIT                                                     also risks to ASB.
                                                                                 $2.30
                                  Exit
                                                                                             A Year in the News:
                                2017E P/E                $1.34
                                                                                             ASB announce new CEO (Apr 4, 2016) – David Singleton has taken the head position at ASB
                2017E                                                                        following Andrew Bellamy’s retirement after 5-years of service as Managing Director and
                                                                            $2.10
              EV/EBITDA                                                                      CEO.

                                2016A P/B                                $1.97               ASB writes back profits from previous years (July 7, 2016) – Upon developments of the
                                                                                             initial stages of the LCS program being less profitable than originally expected, ASB made
                      Target Price                                       $1.95               the decision to write down AUD $156 million in profit.

                                             $1.0        $1.5       $2.0           $2.5
                                                                                             EPF 11 & 12 contract won (Sep 16, 2016) – ASB USA was awarded an A$434m contract for
   Source: Bloomberg, Team Estimates                                                         the design and construction of two Expeditionary Fast Transport (EPF) vessels (EPF 11 and
                                                                                             EPF 12). The two additional EPF grow ASB order book to over AUD $3.3B and extend ASB
                                                                                             USA’s contracted production schedule to CY2022.

                                2.5
                                                        ASB acquires                                                           Delays in LCS 6, Pressure on              Australian Defense White
                                                    Philippines shipyard                                                                  EBIT
                                                                                                                                                                          Paper commits to Navy
ASB Daily Closing Price (AUD)

                                 2                                                                                                                                               spending

                                                                                                    Military Sealift Command
                                                                                                         Hosts Change of
                                1.5
                                                                                                      Command on Austal
                                                                                                              HSSV
                                                                                                                                           Slower than expected EBIT
                                 1
                                                                                                                                            growth on LCS program
                                        9-year low after Equity
                                          raising at 50c share                                                                                                              Write-down of WIP
                                0.5
                                                                                                    ASB secures $697 million                              New CEO announced
                                                                                                    Contract for LCS 14 & 16
                                 0
                                 10/2011            04/2012        10/2012                04/2013      10/2013      04/2014        10/2014        04/2015      10/2015      04/2016      10/2016
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                                         Figure 2: ASB v ASX200
                                                                                                                                   Business Description
                                $3.0                                                           7                                   ASB was founded by current chairman, John Rothwell, in 1987 as a commercial aluminium fishing
ASB Closing Share Price (AUD)

                                                                                                                                   boat builder in Henderson, Western Australia. This saw a period where the company expanded

                                                                                                   ASX 200 Closing Value (000's)
                                $2.5                                                           6
                                                                                                                                   operations into high speed aluminium passenger ferries and cruise ships, before going public in 1998.
                                                                                               5
                                $2.0                                                                                               ASB has since diversified into a global defence prime contractor, providing design, construction and
                                                                                               4
                                $1.5
                                                                                                                                   support capabilities. Construction is undertaken in three yards around the world, with design centred
                                                                                               3                                   at Henderson, WA.
                                $1.0
                                                                                               2
                                $0.5                                                                                               To gain exposure to the world’s largest defence market, ASB USA was established in 1999. ASB USA
                                                                                               1
                                                                                                                                   is ASB’s largest operation by size and revenue, accounting for 84% of revenue in FY2016. ASB USA is
                                $0.0                                                           0
                                                                                                                                   home to the Littoral Combat Ship (LCS) and Expeditionary Fast Transport (EPF) ship building and
                                        Oct-11

                                                 Oct-12

                                                          Oct-13

                                                                   Oct-14

                                                                             Oct-15

                                                                                      Oct-16

                                                                                                                                   support projects for the US Navy. This shipyard is the only foreign defence contractor in the world to
                                                    ASB                     ASX 200
                                                                                                                                   sell ships to the US Navy, the worldwide largest defence spender.

                 Source: Bloomberg                                                                                                 In 2012, ASB opened a shipyard in Cebu, Philippines in a labour cost-cutting initiative. This operation
                                                                                                                                   also gave ASB greater exposure to the South-East Asian seas market. Commercial shipbuilding for
                                        Figure 3: Littoral Combat                                                                  high-speed vehicle-passenger ferries and offshore support vehicles will be mainly now be undertaken
                                               Ship (LCS)                                                                          in Cebu, which will help create greater capacity in the Henderson shipyard. In 2016, ASB re-entered
                                                                                                                                   the Chinese ferry market by forming a joint venture with Jianglong Shipbuilding to further pursue
                                                                                                                                   Asian opportunities.

                                                                                                                                   Lucrative Contracts
                                                                                                                                   Littoral Combat Ship (LCS) Program – The LCS program is the largest shipbuilding project
                                                                                                                                   undertaken in ASB’s history. The program consists of 52 full service naval combatants for the US
                                                                                                                                   Navy, 11 of which have been awarded to ASB USA for construction. This creates an order book of
                                                                                                                                   approximately US $3.5 billion value through 2021, before the potential benefits of ongoing support
                 Source: Austal Website                                                                                            contracts.

                                   Figure 4: Expeditionary Fast                                                                    Expeditionary Fast Transport (EPF) – In November 2008, ASB was awarded as prime contractor to
                                         Transport (EFP)                                                                           build ten, 103m EFPs with a total contract value of US $1.6bn. Austal has so far delivered seven EPF’s,
                                                                                                                                   with three under construction. An additional two EPF’s have been ordered by the US Navy taking
                                                                                                                                   the buy block to 12 ships valued at US$1.9bn. In early 2014, Austal announced it had been awarded
                                                                                                                                   an AUD $124.9m contract for two High Speed Support Vessels (HSSV) for the Royal Navy of Oman.

                                                                                                                                   Strategy
                                                                                                                                   Form a partnership with the Royal Australian Navy – The highest emphasised goal currently
                                                                                                                                   occupying Austal’s focus. Success in this market will provide growth to the strength of the current
                                                                                                                                   order book and form the building blocks of becoming “The Australian Shipbuilder”.
                 Source: Austal Website

                                                                                                                                   Capture opportunities in support functions – A strategic goal to capitalise on the constant annuity
                                                                                                                                   that is a product of support contracts. 10% of the value of a ship is spent per annum on service and
                                                                                                                                   support functions, providing a constant and stable source of revenue with higher profit margins.
                 Figure 5: Shareholder Analysis
                                                                                                                                   Productivity improvement through cost reduction – The goal is to become the world’s lowest cost
                                                                                                                                   producer of ships within the product market. This will be improving on the already competitive
                                                                                                                                   history amongst competitors.
                                50.67                                                   39.92
                                 %                                                       %
                                                                                                                                   Executives
                                                                                                                                   ASB’s executive management team consists of six professionals, led by new CEO, David Singleton
                                                                                                                                   being appointed in April 2016. Singleton brings with him previous experience working in defence
                                                                                                                                   prime contractor businesses, previously working for BAE Systems. (Good move, as Austal continues
                                                                                                                                   to develop into a primarily defence contractor business). The board of directors comprises four
                                                                                                                                   members, with relevant industry experience in defence, engineering and contract work. The board is
                                                                                                                                   chaired by John Rothwell founder.
                                                                            9.41%

                                       Institutional               Insider            Other                                        Shareholder Analysis
                                                                                                                                   ASB CEO David Singleton describes the target shareholder as being long-term growth investors, with
                 Source: Bloomberg
                                                                                                                                   at least a five-year view associated with their investment in the business. At 19.57%, the majority
                                                                                                                                   owner of ASB equity is Allan Gray Australia, an investment fund focused on contrarian asset
                                                                                                                                   opportunities. Allan Gray’s investment fund is focused on long term return appreciation, but has
                                                                                                                                                                                                                             2
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CFA Institute Research Challenge                                                                                                                                                                                          24 Oct 2016
                                                                                                                                                         recently shown the propensity to buy and sell with ASB price fluctuations. The second highest
                                                                                                                                                         shareholder is ASB founder and chairman John Rothwell, at 9.33%.

                                                                                                                                                         Industry Overview and Competitive Positioning

                                 Figure 6: Past 5-year AUS v US                                                                                          The Global Military Shipbuilding Industry
                                     Military Expenditure                                                                                                The past five years have resulted in stunted growth in the Global Military Shipbuilding industry,
                                                                                                                                                         directly affected by declining defence spending in the US and Europe. The global economic slowdown
                                 750                                                                           33
                                                                                                                                                         meant governments attempted to deal with widening budget deficits by cutting defence spending.
                                                                                                                                                         Shipbuilding's long lead times and the industry's importance to national defence meant that industry
                                                                                                                       AUS Military Expenditure - US$B
US Military Expenditure - US$B

                                                                                                               31
                                 700                                                                                                                     projects were less impacted by defence cuts.
                                                                                                               29
                                 650
                                                                                                               27                                        Increases in the US defence budget, growth in defence budgets of key nations around the world and
                                 600                                                                           25                                        a resurgence of global security threats suggest that the global military shipbuilding industry is
                                                                                                               23                                        expected to return to growth in the next coming years as governments increase military spend to
                                 550
                                                                                                                                                         recapitalize their defence infrastructure.
                                                                                                               21
                                 500
                                                                                                               19
                                 450                                                                                                                     Australian Domestic Overview
                                                                                                               17
                                                                                                                                                         The Australian Shipbuilding Industry has rebounded from spending cuts in 2010-11 defence budget
                                 400                                                                           15
                                                                                                                                                         to undergo consistent growth over the past 5 years and is set to continue to grow with the Australian
                                                                                                                                                         Federal government announcing it will invest AUD $89 billion in Navy ships over the next 20 years.
                                                                                                                                                         Industry revenue will be boosted with the Offshore Patrol Vessel (OPV) program, estimated budget
                                                           AUS                                   USA                                                     of AUD $3-5 billion and the Future Frigate program to replace the ANZAC class frigates, estimated
                                                                                                                                                         to be worth AUD $30 billion.

                                                                                                                                                         Historically the Federal Government has awarded all defence shipbuilding and support contracts to
                          Figure 7: Total Market Share of the                                                                                            Australia-based companies, however this has changed in the past 5 years with domestic shipbuilders
                                Shipbuilding Industry                                                                                                    facing strong overseas competition from overseas competitors such as Fincantieri and Navantia for
                                                                                                                                                         these contracts. This is due to foreign shipbuilder’s ability to operate with low wage costs and large
                                                                                                                                                         economies of scale gaining a competitive advantage over Australian firms. Austal’s primary domestic
                                 35%
                                       31.5%                                                                   31.3%                                     focus is on building patrol boats and winning the OPV program could provide in excess of AUD $200
                                 30%                        27.8%                                                                                        million per annum in revenue to Austal for over a decade.

                                 25%                                                                                                                     United States of America and International Overview
                                                                                                                                                         US Navy spending will remain essential for global industry growth as they contribute to more than
                                 20%                                                                                                                     one-third of industry revenue. As the US Navy attempts to meet its objective of creating a 308 ship
                                                                                                                                                         fleet to encounter the challenges of the coming years, demand for new naval vessels is expected to
                                 15%
                                                                                                                                                         rise. The US Shipbuilding industry represent very high barriers to entry with domestic US
                                                                                                                                                         Shipbuilders protected by the Jones Act, where foreign-built vessels are prohibited on routes between
                                 10%
                                                                                                                                                         US ports. This Act extends to Navy procurement.
                                                                                  5.3% 4.1%
                                  5%
                                                                                                                                                         Sequestration and other government spending cuts post presidential election could derail the Navy’s
                                  0%                                                                                                                     procurement plans. However, rising geopolitical tensions and the rise of Chinese Navy and continued
                                                                                                                                                         tension in the south China Sea mean the US is expected to increase spending on Navy products as it
                                                                                                                    Others
                                                             Huntington Ingalls
                                        General Dynamics

                                                                                                  Austal USA
                                                                                   BAE Systems

                                                                                                                                                         pivots its navy toward the more maritime-focused Asia, while also modernising its fleet.

                                                                                                                                                         Drivers for Future Demand
                                                                                                                                                         Federal Funding for Defence – Federal government defence policies, budgets and other political and
                                                                                                                                                         security considerations heavily decide the fate of the Global Military Shipbuilding industry. Winning
                                                                                                                                                         contracts with the US Defence and Royal Australian Navy (RAN) will contribute largely to revenue
             Sources: IBISworld
                                                                                                                                                         growth of the shipbuilding and repair service industry in Australia, especially for Austal. With
                                                                                                                                                         growth in defence budgets, increased government expenditure tends to generate greater demand for
                                                                                                                                                         naval ships.

                                                                                                                                                         Real GDP Growth – Many countries usually expand their fleet when they have the funds to do so.
                                                                                                                                                         When countries’ economies expand, they have more money to spend on defence industry products.
                                                                                                                                                         Conversely, when their economies shrink, defence budgets are cut and funding for defence industry
                                                                                                                                                         products declines. Continued economic growth globally increase the demand for Navy’s to increase
                                                                                                                                                         their fleets.

                                                                                                                                                                                                                                                  3
CFA Institute Research Challenge                                                                                                                             24 Oct 2016
                                                                               Political Tensions and Global Arms War – Geopolitical factors such as increased tensions with rivals,
                 Figure 8: Porter's Five Forces                                wars and national security threats being heightened increase the demand for Navy products.
                                                                               Countries are more pressured than ever to increase spending on new naval ships whilst modernising
                                          Bargaining Power
                                                                               their fleet to maintain its ability to project power abroad, protect trade lanes and defend allies. In
                                          Bargaining Power
                                             of Suppliers
                                                Suppliers                      particular, if a rival navy attains more combat ships, capacity and technology, national Navy’s
                                             of
                                               5                               especially the US will try to outmatch that. Also abnormal events such as terrorist attacks on the US
           Bargaining
                                               4                               on September 11 tend to lead to higher demand for defence equipment.
            Power of
                                               3              Threat of
                 Buyers                        2
 argaining                                                   SubstitutesThreat of
                                               1                              Competitive     Positioning
wer of Buyers                                                          Substitutes
                                               0                               Over the past three decades Austal has built a world renowned business in shipbuilding, systems and
                                                                               support. Centred on their expertise in aluminium design and construction, ASB has utilised this
                                                                               position to expand from predominately commercial shipbuilding contracts to becoming a defence
                                                                               prime contractor. Becoming the first non-American company to win defence contracts with the US
                                                                               Navy is a testament to their success in this transition, and can be attributed to developing a
          Industry                                                Threat of
           Rivalry
              Industry                                    ThreatNew
                                                                 of Entrants   competitive position from their strong base of experience, skill and managerial confidence.
                               Rivals                  New Entrants
                                                                               Austal’s whole-of-ship production capabilities separates them from many other commercial
        Source: Team Estimates                                                 shipbuilders, and continues to be a strength driving the defence contracting growth. Their capabilities
                                                                               in design, construct and support of vessels provides confidence for buyers of an efficient one-stop
                                                                               facility. Whole-of-ship production capability helped win initial contracts with the US Navy, with this
          Figure 9: Australia vs Philippines                                   achievement compounding to securing further lucrative defence contracts, and assuring their global
                 Ave Hourly Wage                                               reputation.

                                     25
                                                                               Efforts to overcome a lull in key commercial ferry markets caused by weak economic conditions in
                Hourly Rate in AU$

                                     20                                        the wake of the 2008 Global Financial Crisis led to the opening of facilities in Cebu, Philippines. This
                                                                               facility is in close proximity to high growth Asian markets, providing a new foothold to expand into
                                     15                                        a new lucrative market. Furthermore, the Cebu facilities frees up capacity constraints on the
                                                                               Henderson facilities, allowing it to focus upon future defence contracts.
                                     10

                                     5                                         Strong and experienced management has been a cornerstone of the company’s success, allowing them
                                                                               to overcome the shrinking ferry demand and mitigate the challenges of transitioning into the defence
                                     0                                         contracting space. With the changes to the businesses operations, Austal has recruited highly
                                     Philippines       Australia               experienced senior management and board members to support the transition into.

        Source: Trading Economics
                                                                               Investment Summary
                                                                               We issue a strong BUY recommendation on Austal Limited with a one-year target price of $1.95 using
        Figure 10: Recommendation Criteria                                     a Discounted Cash Flow to Firm Relative Multiples model. This indicates a 26.6% upside from the
                                                                               October 21, 2016 closing price of $1.54 per share.
           $2.00

                                                                               Merits
                                               Buy                             Balance Sheet Strength – The considerable steps Austal has taken in the past financial year to shore
           $1.90
                                               abov                            up their balance sheet places them in a robust position going forward. The sale of stock products has
                                                 e:                            buoyed ASB to a net positive cash in hand with excess of AUD $220 million at the ready to be
                                               $1.80                           deployed. With the prospective of lucrative defence programs upcoming, this leaves ASB in a strong
           $1.80                                                               position to act on the necessary capital expenditure required to facilitate these major programs.
                                                                               Investments of $50 million in PP&E during FY2016 further solidifies this position and the readiness
                                               Hold
                                                                               undertake new contracts.
           $1.70
                                                                               Strong Pipeline of Contracts – With a current order book in excess of AU $3.5 billion through 2021,
                                                Sell                           Austal is well placed to ensure that shipyards are working at capacity over the short-run until further
                                               belo                            work can be secured. Expansion into new markets including High Speed Support Vessels for Oman
           $1.60
                                                 w:                            and commercial ferries for Denmark show a diversification of business operations. Once the current
                                               $1.70
                                                                               order book has been delivered, ASB should be able to grow its support business which has the
                                                                               potential to become a low risk, high margin annuity.
           $1.50

                                                                               Solidified Position in Defence Sector – Austal’s unique position as the only non-American prime
                         Expected Return (%)
                                                                               contractor for the US Navy is indication of the design innovation and build quality. Proven
                    Sell         Hold        Buy
                                                                               capabilities in delivering on time, cost-effective vessels combined with high industry barriers to
          WACC - 3                          WACC ± 3       WACC + 3            entry/exit places ASB in a secure position going into a change of US government and potential budget
                < 10.6                      10.6 – 16.6       > 16.6           sequestration. Strong performance abroad has demonstrated the capabilities required for potential
        Source: Team Estimates                                                 involvement with planned Australian naval expansion.

                                                                                                                                                                          4
CFA Institute Research Challenge                                                                                                                   24 Oct 2016

                   Figure 11: LCS Modifications            Further Along the Cost Curve – Minimal reference points caused integration difficulties in the initial
                                                           phases of the LCS program due to Austal’s unique aluminium trimaran. With over 5,000 design
                                                           modifications each to LCS 6 and LCS 8, the increased costs related with the design modifications
  LCS 6                                            5,200   reduced profitability on the early ships. Vessel modifications have fallen continuously from LCS 8 to
  LCS 8                                            5,400   LCS 20, allowing ASB to now produce further along the cost curve and reap the benefits of the fixed-
                                                           price incentive contract structure of the current 10 ship buy block. A continuation of the LCS program
 LCS10                                           4,900
                                                           and the associated design streamlining forms the basis of our gross profit growth assumptions from
LCS 12                                          4,500      its current level at 6.6% to 9% in 2026.
LCS 14                                     3,700
                                                           Concerns
LCS 16                                  2,900
                                                           Long-run Uncertainty – Being so heavily involved in contract work causes cash flow uncertainty past
LCS 18                          1,300                      the known pipeline of 2021 when LCS 26 is scheduled to be completed. Funding to the Department
LCS 20                    300                              of Defence is subject to change at the discretion of political motives. A dependence on revenue
                                                           streaming from a limited number of sources increases the risk profile of Austal should there be
                                                           changes from the status-quo.

Source: Company Data                                       Negative US Press Towards LCS Program – While the US Navy continue to publically voice their
                                                           support for the LCS program, there are high-ranking Senate members of the Armed Services
                                                           Committee (SASC) and media pundits who vocally express their disdain for the program. Much of
Figure 12: Target Price Components                         criticism surrounds the ships initial costs overruns, and perceived limited lethality capabilities against
                   $2.0                                    air, sea and subsea adversaries. The US Navy continues to back through numerous administration
                                                           and leadership changes with the LCS forming a key role in the Navies strategic strategy going
                   $1.8             P/B                    forward building toward a 300 ship strong Navy.
                                   $0.39
                   $1.6
                                   EV/E                    Valuation
                   $1.4            BITD                    Our price target of $1.95 was formed with equal weightings between 10yr DCF perpetuity growth,
                                     A
                   $1.2
                                                           10yr DCF exit multiple, Price/ FY+1 Earnings, Enterprise Value / FY+1 EBIT, and Price / Book value.
                                   $0.42
                                                           Forward year earnings estimates were used as last years’ results were marred by the AUD $156
                                    P/E
                   $1.0                                    million write down to works in progress, which we don’t expect to be recurring.
                                   $0.27
                   $0.8
                                   EBIT                    We chose a combination of valuation methods in our assessment of Austal, choosing a 40-60 split
                   $0.6             exit                   between discounted cash-flows (DCF) and comparable multiples respectively. This places less
                                   $0.46                   emphasis on the lack of predictability surrounding the future growth prospects of ASB, and more on
                   $0.4                                    relative valuations of comparable companies. Relative valuation multiples also encompass the much
                                   Perp
                                   etuit                   of the variables used in the DCF model, such as expectations of cash flows and risk, and are priced
                   $0.2
                                     y                     accordingly. Austal’s failure to pay consistent dividends over the previous 5-10 years, and their lack
                   $0.0            $0.41                   of current dividend policy were reasons the DDM model was not used.

Source: Team Estimates                                     Sensitivity tables varying the WACC in the DCF valuations Appendix G, and small multiple ranges
                                                           around the comparable medians were used to plot high low prices, the midpoints of which were
                                                           averaged to give us our price of $1.95 This implies ASB’s EV/FY+1 EBIT of 12.0x and EV/FY+1 EBITDA
                                                           of 8.1x, a 26.6% premium over its $1.54 closing price on 21 October.
                                                                                                                        st

               Figure 13: Historical Dividend
                          Payouts
                                                           Discounted Cash Flow Model
                                                           The DCF method was used to discount to present value, the estimated Unlevered Free Cash-Flows to
                    14
                                                           Firm (FCFF). FCFF is the standard measure of how much cash the company has left over, after
                    12                                     accounting for expenses, capital expenditure and before debt repayments. It gives investors an
                                                           indicator how much cash is available to pay-down debt, and increase shareholder wealth.
 Cents per share

                    10

                     8
                                                           We chose to use a 10-year DCF model so that we could more gradually bring Austal’s margins in line
                     6                                     with their targets. The key assumptions driving the DCF model are detailed below. This is illustrated
                     4                                     in Appendix F.

                     2
                                                           Revenue - Austal’s largest current source of revenue is from their US Operations in Mobile, Alabama,
                     0                                     as seen in Figure 14. This has been due to the recent LCS contracts which have doubled ASB’s
                                                           revenues over the previous 5 years. The US Secretary of Defence has recently put forth plans to reduce
                                                           the Navy’s total buy from 52 to 40 ships, and even changing from a split buy to a single manufacturer,
Source: 2016 Annual Report
                                                           though the US Senate and Congress have somewhat halted this decision. The final verdict on the

                                                                                                                                                        5
CFA Institute Research Challenge                                                                                                                                            24 Oct 2016
                                                                                        continuation of the LCS program will be made by the new government forming late 2016, with the
                          Figure 14: Revenue from ASB                                   last ships likely being more combat focused frigates.
                                  Subsidiaries                                          The Australian government has also announced its plans to spend $39 billion on new navy ships, and
                          $1,600                                                        we believe Austal is in a prime position to win some portion of that deal in the form of the Future
                                                                                        Frigate program.
                          $1,400

                          $1,200                                                        While we view the future outlook for Austal highly, their current order book in excess of AUD $3.5
 Revenue (AUD millions)

                                                                                        billion through 2021 forms the basis of our conservative revenue growth assumptions. These future
                          $1,000                                                        contracts though are problematic to predict and value, and we acknowledge that any new contracts
                                                                                        being finalised in the near term will dramatically raise our revenue assumptions and price target
                           $800                                                         going forward.

                           $600                                                         Terminal Values – The first method for estimating the 10 year terminal value was an EBIT exit
                                                                                        multiple of 11x EBIT multiple was used as it better represents the depreciation levels of Austal’s
                           $400
                                                                                        largest assets, its property plant and equipment (PP&E). This multiple was sourced from the median
                                                                                        EV/ FY+1EBIT multiples of our 8 chosen comparable companies.
                           $200

                              $-                                                        A perpetuity growth rate of 2.5% to grow the terminal value of the final FCFF in our other DCF
                                                                                        valuation. The growth rate is centred on the RBA’s target for inflation of 2-3%, and too was a modest
                                    2010
                                            2011
                                                   2012
                                                          2013
                                                                 2014
                                                                         2015
                                                                                 2016

                                                                                        assumption considering the lack of certainty behind their future contracts. See Appendix F.
                            US       Australia & Phillipines
                                                                                        Weight Average Cost of Capital (WACC) – Austal’s WACC was calculated using a build-up method
Source: Annual Reports
                                                                                        based around CAPM. Cost of equity was calculated using the Capital Asset Pricing Model (CAPM).
                                                                                        The 10-year Australian Government bond rate of 2.26% was selected in order to match the analysis
Table 1: Weighted Average Cost of
                                                                                        period. Beta was determined using the Defence Industry Beta by NYU Stern at 1.30. The market risk
       Capital Components
                                                                                        premium was calculated at 7.37% based on a 10 year historical examination of the Australian market
                                                                                        risk premium. ASB’s size also warranted a firm-size premium of 2.5% in order to account for the
                             WACC Breakdown
                                                                                        riskiness of the relatively small firm. See Appendix H.
    Risk-free Rate                                                2.26%

    Beta                                                                1.30            Using industry averages for defence and shipbuilding we determined a 3.6% pre-tax cost of debt.
                                                                                        Industry average debt and equity ratio of 0.19, and USA’s marginal tax rate of 40% were then used to
    Market Risk Premium                                           7.37%
                                                                                        calculate ASB’s WACC of 13.6%.
    Cost of Equity                                                13.2%

    Cost of Debt                                                    3.6%                Relative Valuation
                                                                                        Austal’s size and location make it difficult to find direct competitors. Of the 8 companies chosen 6
    Marginal Tax Rate                                                   40%
                                                                                        were defence and naval contractors, 4 being direct competitors for future LCS and Australian frigate
    Weight of Equity                                                    81%             contracts. The list was rounded out with 2 Australian based engineering firms, who source much of
                                                                                        their revenue from contract based manufacturing and more closely emulated ASB’s size. Before we
    Weight of Debt                                                      19%
                                                                                        begun comparing multiples, data from our chosen peers was converted into AUD $, while this was
    WACC                                                         13.60%                 not strictly needed for multiple calculations, it does show a better view of the size of the various
Source: Bloomberg, Team Estimates                                                       companies, across 5 different countries. See Appendix I.

                                                                                        Due to ASB’s write-down in 2016, their negative earnings cause mostly negative valuation multiples.
                           Table 2: Relative Multiples                                  Earnings based multiples used 2017 forecasts for ASB’s EBITDA and Earnings with Bloomberg
                                                                                        estimates for the comparable companies. Price / Earnings was used as a good metric to compare
                                                                                        against selected industry peers, the value the market puts on $1 of ASB’s earnings. The EV/EBITDA
                                    P/E       EV / EBITDA                P/B
                                                                                        multiple expands on this concept further. The median value of 15.3x implies ASB’s EV to be $381
        ASB:AU                     16.7 x            5.9 x               1.1 x          Million, with a share price of $1.24.
        LMT:US                     19.3 x           12.2 x              21.8 x
                                                                                        Where share price equates to the market value of a company’s common equity, enterprise value
        GD:US                      15.3 x            9.9 x               4.1 x
                                                                                        expands further on the true value of the entire company, by subtracting cash levels and adding in
        BA/:LN                     13.6 x            8.7 x               4.6 x          their total debt. EBITDA too gives a better comparable picture of earnings from an outside
                                                                                        perspective, where capital structure can greatly affect the bottom line earnings levels. The median
        HII:US                     14.6 x            7.9 x               4.7 x
                                                                                        value of 8.7x implies ASB’s EV to be $657 Million, with a share price of $2.04.
        FCT:IM                     101.1 x          12.0 x               0.6 x

        WOR:AU                     17.3 x            8.7 x               1.2 x          The last multiple used was Price/Book value. The data used was normalised to IFRS standards as to
        6269:JP                    11.1 x            9.7 x               1.1 x
                                                                                        better compare the internal asset valuation methods between companies. P/B is used as an indicator
                                                                                        of the value the market places on the book value of a companies’ equity. The median P/B of 1.6x
        UGL:AU                     11.0 x            5.2 x               1.6 x          implies an EV of $681 Million, with a share price of $2.11. See Appendix J.
        Median:                    15.3 x            8.7 x               1.6 x

Source: Team Estimates

                                                                                                                                                                                 6
CFA Institute Research Challenge                                                                                                                                                            24 Oct 2016

                                                                                                         Financial Analysis

     Figure 15: EBIT vs EBIT Margin                                                                            Financial Ratios        Unit     2015A     2016A     2017E    2018E     2019E     2020E    2021E

                                                                                                          Profitability Ratios

   105                                                                                            8%      Operating Profit Margin       %        8.31     -4.34     6.60      7.10      7.90      8.05     8.20

                                                                                                          EBITDA Margin                 %        7.75     -6.79     5.34      5.87      6.81      7.03     7.24
        80                                                                                        6%
                                                                                                          EBIT Margin                   %        6.03     -9.03     3.60      4.10      5.00      5.18     5.36

                                                                                                          Net Income Margin             %        3.76     -6.29     2.00      2.41      3.07      3.24     3.41
        55                                                                                        4%
                                                                                                          Return on Assets              %        4.97     -8.31     2.78      3.42      4.40      4.67     4.90
        30                                                                                        2%      Return on Fixed Assets        %        12.01    -17.15    5.31      6.82      9.26     10.45     11.78
                                                                                                          Return on Equity              %        10.37    -18.40    6.02      7.27      9.08      9.36     9.56
Millions $

                 5                                                                                0%
                                                                                                          Liquidity Ratios
                                                                                                          Current Ratio                  x        1.30     1.53      1.37      1.41     1.50      1.59     1.69
     -20                                                                                          -2%
                                                                                                          Cash Ratio                     x        0.30     0.73      0.61      0.65     0.73      0.82     0.93
     -45                                                                                          -4%     Quick Ratio                    x        0.53     1.15      1.00      1.04     1.13      1.22     1.32
                                                                                                          Efficiency Ratios
     -70                                                                                          -6%
                                                                                                          Total Asset Turnover           x        1.43     1.29      1.39      1.44     1.46      1.47     1.47
                                                                                                          Fixed Asset Turnover           x        3.50     2.87      2.76      2.80     2.98      3.18     3.40
     -95                                                                                          -8%
                                                                                                          Current Asset Turnover         x        2.54     2.50      3.15      3.34     3.20      3.03     2.86

-120                                                                                              -10%    Inventory Turnover             x        3.88     6.23     12.06     12.23     12.18    12.23     12.23
                                                              2018 E
                                                     2017 E

                                                                       2019 E
                                                                                2020 E
                                                                                         2021 E
                                   2015 A
                                            2016 A

                                                                                                          Leverage Ratios
                                                                                                          Long-term Debt-to-Asset        x        0.01     0.17      0.15      0.13     0.12      0.10     0.09
                                        EBIT                             EBIT Margin                      Long-term Debt-to-Equity       x        0.01     0.37      0.33      0.28     0.24      0.20     0.17
  Source: 2016 Annual Report, Team                                                                        Debt to Equity                 x        1.09     1.21      1.17      1.13     1.06      1.01     0.95
  Estimates                                                                                               Net Debt to Equity             x        0.03     -0.11     -0.08    -0.15     -0.23    -0.40     -0.47
                                                                                                          Debt to Capital                x        0.52     0.55      0.54      0.53     0.52      0.50     0.49
                                                                                                          Equity Ratios
                                                                                                          Earnings Per Share (EPS)       $        0.15     -0.24     0.08      0.10     0.14      0.15     0.16
   Figure 16: Historical and Forecasted                                                                   Book Value Per Share           $        1.48     1.32      1.35      1.41     1.49      1.59     1.70
                 Revenue
                                                                                                          Asset Value Per Share          $        3.09     2.91      2.93      2.99     3.08      3.19     3.32
                                                                                                          Growth Ratios
                                  $1,800
                                                                                                          Sales Growth                   %        26.0     -5.3      5.6       4.5       4.0      4.0       4.0
                                  $1,600
                                                                                                          Operating Income Growth        %        53.5    -241.7    -142.1     19.0     26.8      7.7       7.6
        Revenue ( AUD millions)

                                  $1,400
                                                                                                          Net Income Growth              %        66.8    -258.4    -133.6     25.6     32.6      9.9       9.4
                                  $1,200                                                                 Source: Bloomberg, Team Estimates
                                  $1,000
                                                                                                         Overview
                                   $800
                                                                                                         The financial ratios chart above reveals ASB’s prospects moving forward, highlighting our
                                   $600                                                                  assumptions Historical data is presented from FY12-16 with forecasting period from 2017E-2021E.
                                   $400
                                                                                                         Flexibility in Financing New Contracts
                                   $200
                                                                                                         ASB’s extra capacity for debt, positions it well to finance future growth opportunities. ASB has the
                                        $0                                                               option to finance new opportunities with its cash in hand or debt. Historically the financial statements
                                                                                                         have shown strong liquidity ratios, highlighted with the FY16 current ratio at 1.53x and interest
                                                                                                         coverage ratio >4.0x historically, ignoring FY16 results due to the LCS write-downs. We expect this to
  Source: Bloomberg, Team Estimates
                                                                                                         continue in the near future.

                                                                                                         This puts ASB in a strong credit position and demonstrates the ability to meet its interest payments
                                                                                                         and debt obligations. The FY16 long-term debt to asset ratio is currently 0.17x, with majority of debt
                                                                                                         consisting of tax-exempt Go Zone Bonds (avg. cost of 1.85%). The abnormally low rate of debt creates
                                                                                                         a position where ASB is better served holding onto its cash and receiving tax benefits from these
                                                                                                         bonds than repaying.
                                                                                                                                                                                                  7
CFA Institute Research Challenge                                                                                                            24 Oct 2016

                                                      Sustainable Earnings
                    Figure 17: Efficiency Ratios      ASB’s revenue and EBIT margins are reliant on contract wins and as a result could see future high
                                                      fluctuation. The procurement of the Cebu shipyard emphasises ASB’s strategy to reduce labour costs
                    8                                 and hence boost margins. Between FY12 and FY16 ASB’s revenue doubled to AU$1.3B, with two
                                                      major contracts with the US Navy coming into full operation during this period. FY16 however saw
 Efficency Ratios

                    6                                 negative EBIT due to WIP write-downs on the LCS operations, and reduced demand in Philippines
                    4                                 and Australian operations over the year. Through successful acquisition of new commercial contracts
                                                      for the Philippines and PPB for the Australian operations our group estimates show ASB returning
                    2                                 to positive EBIT in FY17. EBIT should continue to grow with a number of key contracts being awarded
                                                      in past 12 months coming on line in the coming periods to further improve margins.
                    0

                                                      Efficiency Ratios
                          Total Asset Turnover        Over the preceding five years ASB has seen a steady albeit fluctuating improvement over the four
                          Fixed Asset Turnover        key efficiency ratios. Total Asset turnover, Fixed Asset turnover and Current asset turnover all
                                                      reached highs in FY15 before falling slightly during FY16. Total Asset turnover saw improvements
                          Current Asset Turnover
                                                      from 0.79x FY12 to 1.29x FY16 down from FY15 high due to a reduction in current assets from the sale
                          Inventory Turnover
                                                      of inventory and WIP write down. Fixed Asset turnover improved from FY12 levels of 1.76x to 2.87x
Source: Company Data                                  FY16 down from high in FY15, from an increase in PP&E at the same time revenue decreased over
                                                      the year. Current Assets rose from 1.49x FY12 to 2.5x FY16, with a small drop from FY15 due to
                                                      aforementioned reduction in Inventories. All three are expected to maintain trend improvement over
                                                      FY17. Inventory turnover likewise saw improvements over the FY12 – FY16 period of 3.15x to 6.23x
                                                      with the jump in FY16 increase coming from the aforementioned changes in inventory. This growing
                                                      trend of improving asset utilisation bodes well for the forward outlook.
                    Figure 18: DuPont Analysis
                         (2016A | 2021E)
                                                      DuPont Analysis
                                                      Historically, ASB has shown steady growth in profitability, with FY15 ROE of 10.37%. The WIP write
                                                      down of the LCS program in FY16 saw ROE fall to –18.4%. We forecast a return to positive ROE in
                                                      FY17 of 6.02%, with steady growth returning to FY15 levels at the end of our analysis period. Our
                                                      analysis showed ROA being a main driver, and looking forward through our decomposition,
                                                      profitability will be driven by improvements in operating efficiency. Following the expiration of
                                                      cheap long term debt, moving into a more equity based model will lead to a further improved
                                                      financial leverage position. See Appendix V.

Source: Bloomberg, Team Estimates                     Monte Carlo Simulation
                                                      A Monte Carlo Simulation was conducted to simulate the impact that variation in key variables would
                                                      have on the share price. 10,000 iterations of the simulation were run accounting for these internal and
                                                      external variances.

                                                      In defining gross profit and revenue a scenario analysis was used allowing for upper and lower
   Table 3: Monte Carlo Simulation                    bounds derived from financial forecasts. A dual approach was taken in calculating an appropriate
              Statistics                              gross profit volatility, using ASB’s historical margin in conjunction with the proportion of ship costs
                                                      exposed to material volatility such as aluminium and steel. Distributions for the risk free rate,
               Summary
                                                      perpetuity growth and market return were derived from historical analysis of the 10-year Australian
 Number of Iterations         10,000
                                                      government bond, RBA inflation band and the ASX200 respectively.
 Minimum                       $1.57
 Maximum                       $2.13
 Mean                          $1.85
                                                      These inputs, as seen in Appendix W, forecast a 1-Year Price Target of $1.85 and a 77.24% confidence
 Skewness                     -0.193                  in our BUY recommendation.
 Kurtosis                      2.799
 Median                        $1.85
 5% CI                         $1.71                                                       Figure 21: Monte Carlo Simulation
 95% CI                        $1.98
 % of Simulations > 1.79      77.24%
                                                   Probability

 % of Simulations < 1.79      22.76%
Source: Team Estimates, Bloomberg,
ModelRisk

                                                                                                     ASB Share Price (AUD)
                                                      Source: Team Estimates, Bloomberg, ModelRisk
                                                                                                                                                8
CFA Institute Research Challenge                                                                                                            24 Oct 2016
                                                      Corporate Governance

       Table 4: Board of Directors Peer               Management
                 Comparison                           The management team at Austal is comprised of four directors each of which possesses a strong
                                                      background in shipbuilding, defence or engineering. Non-Executive Chairman and Founder John
                    Board of Directors                Rothwell has over 40 years of experience in shipbuilding and facilitated the transition of Austal from
 Ticker       No.               Tenure       Shares   commercial to defence work. Chief Executive Officer David Singleton has previous experience in the
 ASB           4                  9.6        9.35%    role of CEO in both the defence and engineering industries. Independent directors Jim McDowell and
 LMT          10                  7.8        0.06%    Giles Everist provide defence and finance experience respectively. See Appendix O
 BAE          11                   4         0.07%
 HII           8                  4.5         1.8%
Source: Bloomberg
                                                      Governance
                                                      Austal is compliant with the majority of guidelines stipulated in the ASX Corporate Governance
                                                      Council’s Principles and Recommendations. This includes the formation of the Nomination and
                                                      Remuneration Committee and Audit & Risk Committee to oversee internal controls, policies and
                                                      compensation.

                                                      The equity holdings of board members John Rothwell (9.3% equity stake) and David Singleton (share
              Table 5: Beneficial Ownership           based remuneration package) disqualify them from an independent classification. As only 2 of the 4
                                                      board members can be classified as independent, this raises questions regarding the independent
   Stakeholders                Outstanding            judgement and decision making ability of the board. There is an overlap of 2/3 audit and
                                 Shares               compensation committee members which research suggests can improve intra-board information
  Directors                      9.34%                flows and financial reporting quality at the potential expense of governance quality. Third party
                                                      governance analyst ISS rates Austal 8/10 (High Risk) echoing the concern regarding the sub-optimal
  Executives                      0.01%
                                                      board and committee structure. ASB’s increased susceptibility to weaker corporate governance is also
  Total                           9.35%               demonstrated through defence contractor peer comparison. The smaller board size with increased
Source: 2016 Annual Report                            tenure and percentage of outstanding shares is indicative of management entrenchment.

                                                      Corporate Social Responsibility
                                                      By analysing Austal’s commitment to social objectives, CSRHub calculated a 56/100 rating for overall
                                                      CSR, placing it in the 62nd percentile for the manufacturing industry. Austal’s key strategies regarding
                                                      these objectives can be summarised as follows:

                                                      Employees – Austal has established a supportive, diverse and community-oriented workplace that
                                                      aims to retain employees and promote a work-life balance. Austal’s Equity and Diversity reports
                                                      detail their commitment to inclusiveness including a fair representation of women in management
                                                      and professional roles

                                                      Environment – Projects are delivered in an environmentally responsible manner in compliance with
                                                      relevant environmental laws and regulations as outlined in Austal’s Environmental Policy Summary
                   Figure 19: Risk Matrix
                                                      Community – Austal supports organisations targeting mental and physical health through its “Austal
               5                                      Giving” program by giving financial support, leadership and advocacy of health initiatives. Austal
                                                      has assisted to charities such as Cystic Fibrosis WA, Anglicare WA and Lifeline WA.
               4
Probability

               3                MR1            BR1    Investment Risks

               2    MR2         OR2
                                                      Business Risk
               1                      OR1             Contract Risk (BR1) - In order to maintain strong revenue growth, ASB must continue to service and
                                                      acquire contracts to ensure shipyards are working near capacity over the valuation period. ASB
                      1    2     3       4      5     currently holds a contract pipeline of AUD $4 billion through 2021 across their three shipyards. US
                                                      operations contributed to 84% of total revenue during FY16 indicating there currently there exists a
                               Impact
                                                      large dependence on the success of US operations and in particular the LCS program. The proposed
Source: Team Estimates
                                                      truncating of the LCS program would drastically alter the valuation should the US Navy decide not
                                                      to continue with ASB’s trimaran LCS design. Whilst the Mobile shipyard would be repurposed to
                                                      accommodate alternative work, a dissociation from the US Navy would likely have disastrous flow-
                                                      on effects including diminishing the possibility of landing additional work for the Royal Australian
                                                      Navy (RAN).

                                                      Following the Federal Government’s decision to reinforce the RAN through an AUD$89bn
                                                      investment in surface ships and submarines, ASB shifted its Australian focus into securing the build

                                                                                                                                                 9
CFA Institute Research Challenge                                                                                                24 Oct 2016
                                           contracts for the Offshore Patrol Vessel (OPV) and Future Frigate programs. With construction
                                           commencing in 2018 and 2020 respectively, these programs represent significant opportunities for
                                           ASB to secure a long-term contract pipeline and establish themselves as the premier Australian
                                           shipbuilder.

Figure 20: Military Expenditure as a       Failure to win these contracts would reduce revenue generation in the latter years of our valuation
        Percentage of GDP                  and potentially lead to under-utilisation of Australian operations resulting from the lack of work.
                                           Assuming the continuation of the LCS program which contributes the bulk of current revenue,
5%                                         minimal effects would be seen to the valuation. However, being overlooked for the OPV and Future
                                           Frigate programs would signify a lack of faith from the RAN and potentially diminish future
4%                                         prospects whilst also missing out on this generation of Australian shipbuilding.

3%
                                           Operational Risks
                                           Transition from Aluminium to Steel (OR1) – Both the Future Frigate and Offshore Patrol Vessel
2%
                                           programs will be steel-hulled ships, requiring a deviation from ASB’s historically aluminium designs.
                                           Steel is traditionally easier to weld with than aluminium however the transition does increase the
1%
                                           level of operational risk associated with selecting ASB as the shipbuilder. The success of the Pacific
                                           Patrol Boat contract consisting of 19 steel-hulled vessels will be instrumental in demonstrating ASB’s
0%
                                           steel shipbuilding competency for these future projects.

                                           Margin (OR2) – Our valuation is predicated on the growth of Austal’s operating margins over the 10
               US          AU              year DCF period as a function of the continued growth of the support business and the stability of
                                           input costs. Given ASB’s EBIT target of 5-7%, an EBIT of 3.6% in FY 2016 rising to 6.3% in FY 2026
Source: Bloomberg                          should provide conservative earnings estimates. Should margins stay constant at 3.6% and fail to
                                           reach ASB’s targets, a $1.72 price would be reached issuing a HOLD recommendation.

                                           Market Risks
                                           Foreign Exchange (MR1) - ASB faces exposure to currency movements on future transactions
                                           denominated in currencies other than AUD for the Australian operation and USD for the US
                                           operation. Foreign currency exposures are 100% hedged for known input costs and contracted
       Table 6: Risk Mitigation
                                           receipts. A stronger USD reduces US input costs and increases relative Australian export
                                           attractiveness. In recent years, the strong USD has additionally provided a tailwind for profit
     Risk       Mitigating Factors         translation from US operations. The 2016 Annual Report also shows a high level of exposure to the
 Material        Pacific Patrol Boat to    EUR/AUD and EUR/USD rates on equity valuation.
 Transition                demonstrate
                            capabilities   Macroeconomic Trends (MR2) – A high level of correlation exists between military expenditure and
 Margin            Growth of low-risk      GDP including a soft 2% target set by the Australian government. Despite this correlation,
                support business and       governments aim to allocate defence spending with respect to security requirements rather than
                    input cost stability
                                           solely GDP. An economic slowdown would have tangible, albeit slightly delayed effects felt through
 Foreign              Hedge all known
                                           tightening fiscal policy. Defence spending as a portion of GDP is trending downwards in the US
 Exchange        inputs and contracts
 Contract      Diversification of client
                                           indicating a public focus in alternative sectors placing ASB’s largest source of revenue generation at
                     base to reduce the    potential risk. On the commercial side of business where shorter lead times and contract lengths allow
                  dependence on LCS        for greater elastic demand variability, economic instability would have a more pronounced effect.
 Macro             Securing long-term
 Trends          contracts that bridge     Political Risks
                                  cycles
                                           Policy Change (PR1) – As primarily a defence contractor, ASB’s vessel demand is at the discretion of
 Policy         Future expansion into
                                           global political agendas, in particular Australian and the US. Reductions in military presence or
 Change            integral Australian
                                projects   expenditure would pose a significant risk to our valuation as the LCS/FF programs are the key drivers
Source: Team Estimates                     of ASB’s growth potential and future development.

                                           The LCS program has already faced pressures from the current US Secretary of Defence to downsize
                                           from 52 to 40 ships whilst committing to a single design. The next executive branch will be expected
                                           decide on the direction of the LCS program and given the pro-military backgrounds of both 2016
                                           presidential candidates’ significant naval cutbacks are unlikely. However, further legislative branch
                                           disapproval regarding the LCS may cause funding problems regardless of president.

                                                                                                                                   10
CFA Institute Research Challenge                                                                                                                            24 Oct 2016

Appendix A:             Statement of Financial Position
                        In 000s’ AUD $

                                          2012 A      2013 A      2014 A      2015 A      2016 A      2017 E      2018 E      2019 E      2020 E      2021 E          2026 E
Assets
Current Assets
 Cash and equivilents                     $51,811     $38,030     $74,428    $138,413    $224,318    $192,390    $213,089    $246,844    $288,365    $336,804     $688,748

 Trade and receivables                     96,172     102,743      95,753     104,315     128,340     121,747     127,226     132,315     137,608     143,112         174,118

 Inventories                              193,529     277,888     328,142     339,703     108,974     110,044     114,380     117,931     122,449     127,139         153,420

 Prepayments                                 6,538       7,653       4,054       6,321       5,408       2,356       2,462       2,476       2,548       2,622          3,022

 Derivatives                               36,041        7,749       2,701        106         147         141         148         154         160         166            202

 Assets held for sale                        1,561          -           -           -        2,908       2,908       2,908       2,908       2,908       2,908          2,908

Total Current Assets                     $438,592    $503,736    $514,610    $598,913    $470,095    $429,587    $460,213    $502,627    $554,037    $612,751    $1,022,417

Non-Current Assets
 PP&E                                     370,383     399,917     366,500     442,522     490,798     532,406     521,092     508,785     495,445     481,032         391,293

 Other financial assets                       944        4,141          -        3,784       7,638       7,638       7,638       7,638       7,638       7,638          7,638

 Derivatives                               10,625        1,651       5,787          9         340         340         340         340         340         340            340

 Deferred tax assets                          380      22,647        9,022     14,089      34,959      34,959      34,959      34,959      34,959      34,959          34,959

 Intangibles and goodwill                    5,045     12,526        9,473       9,637       9,296     14,939      16,118      17,345      18,620      19,947          27,420

Total Non-Current Assets                 $387,395    $440,882    $396,687    $470,041    $543,031    $590,281    $580,147    $569,066    $557,003    $543,916     $461,650

Total Assets                             $825,987    $944,618    $911,297 $1,068,954 $1,013,126 $1,019,869 $1,040,360 $1,071,694 $1,111,039 $1,156,667           $1,484,067

Liabilities
Current Liabilities
 Interest bearing loans                   -$18,973   -$243,614    -$13,192   -$144,979     -$2,545     -$2,291     -$2,061     -$1,855     -$1,670     -$1,503          -$887

 Trade and other payables                 -128,626    -133,813    -183,570    -223,497    -229,774    -220,088    -228,761    -235,862    -244,897    -254,278     -306,840

 Derivatives                                -2,186     -12,193      -1,972     -21,337     -10,690     -14,138     -14,775     -15,366     -15,980     -16,619        -20,220

 Provisions                                -18,250     -25,128     -33,704     -33,830     -42,291     -42,415     -44,324     -46,097     -47,941     -49,858        -60,660

 Deferred grant income                      -3,561      -4,221      -3,550      -3,244      -8,543      -5,655      -5,910      -6,146      -6,392      -6,648         -8,088

 Income tax payable                        -27,394     -24,537     -10,980      -7,493         -98         -23         -28         -35         -38         -41            -58

 Pre-payments                              -27,288     -21,790     -29,062     -26,177     -12,812     -29,345     -30,501     -31,448     -32,653     -33,904        -40,912

Total Current Liabilities                -$226,278   -$465,296   -$276,030   -$460,557   -$306,753   -$313,956   -$326,360   -$336,810   -$349,571   -$362,851   -$437,666

Non-Current Liabilities
 Derivatives                                -5,757      -4,885      -2,229     -14,737      -5,712      -5,712      -5,712      -5,712      -5,712      -5,712         -5,712

 Interest bearing loans                   -246,444      -1,163    -142,264      -7,658    -170,066    -153,059    -137,753    -123,978    -111,580    -100,422        -59,298

 Provisions                                 -2,060      -2,217      -1,023      -1,139      -1,052      -1,052      -1,052      -1,052      -1,052      -1,052         -1,052

 Deferred govt grants                      -48,753     -52,794     -49,892     -63,722     -71,991     -76,497     -81,003     -85,509     -90,015     -94,521     -117,051

Total Non-Current Liabilities            -$322,662    -$72,135   -$202,035    -$95,998   -$248,821   -$236,320   -$225,520   -$216,251   -$208,359   -$201,707   -$183,113

Total Liabilities                        -$548,940   -$537,431   -$478,065   -$556,555   -$555,574   -$550,276   -$551,880   -$553,061   -$557,930   -$564,558   -$620,779

Equity
 Contributed equity                        31,762     111,328     111,598     112,523     114,738     114,738     114,738     114,738     114,738     114,738         114,738

 Reserves                                  22,595      37,309      27,292      55,846     100,672     100,672     100,672     100,672     100,672     100,672         100,672

 Retained earnings                        222,690     258,560     294,041     343,798     242,142     254,182     273,070     303,223     337,699     376,700         647,878

Total Equity to owners                   $277,047    $407,197    $432,931    $512,167    $457,552    $469,592    $488,480    $518,633    $553,109    $592,110     $863,288

                                                                                                                                                                 11
CFA Institute Research Challenge                                                                                                                   24 Oct 2016

Appendix B:              Statement of Cash-flows
                         In 000s’ AUD $

                                           2012 A     2013 A     2014 A     2015 A     2016 A      2017 E     2018 E     2019 E     2020 E     2021 E          2026 E
Cash flow from operating activities

 Net Income / (loss) after tax              $11,043    $35,742    $31,859    $53,156   -$84,182    $28,249    $35,461    $47,057    $51,719    $56,588         $84,696
 Depreciation and amortisation               16,324     24,509     23,776     24,266     29,899     23,429     24,907     26,443     28,041     29,703          39,065
 Total changes in Working Capital            13,504   -117,496    -10,159     51,235    159,161     16,037      2,706      1,997      3,058      3,171           3,804
Cash from (used) in operating activities     33,136    -55,868     41,628    110,434    102,066     67,715     63,073     75,498     82,818     89,463         127,565

Cash flow from investing activities

 Purchase of PP&E                          -131,459    -21,265    -11,884    -28,126    -12,793    -70,692    -14,775    -15,366    -15,980    -16,619         -20,220
 Receipts from govt grants                    8,698      4,763      4,506      4,986     14,463      4,506      4,506      4,506      4,506      4,506           4,506
 Proceeds from sale of PP&E                      0       9,351     24,611      2,355      2,469      5,655      1,182      1,229      1,278      1,330           1,618
 Purchase of intangible assets               -1,849     -3,478     -1,263     -1,053       -995     -5,643     -1,179     -1,227     -1,276     -1,327          -1,614
Cash from (used) in operating activities   -124,610     -6,645     18,972    -21,838    -24,977    -66,173    -10,266    -10,857    -11,471    -12,111         -15,711

Cash flow from financing activities

 Repayments of debt                         -40,557    -93,368   -114,238    -40,575    -11,992    -17,261    -15,535    -13,981    -12,583    -11,325          -6,687
 Dividends paid                             -11,284         -          -      -3,468    -15,767    -16,208    -16,573    -16,905    -17,243    -17,588         -19,418
Cash from (used) in financing activities     18,191     64,168    -89,321    -34,594     -4,713    -33,470    -32,108    -30,886    -29,826    -28,913         -26,105

Change in cash and equivalents              -73,283      1,655    -28,721     54,002     72,376    -31,928     20,699     33,755     41,521     48,440          85,749

Cash and equivilents

 Cash at beginning of year                  171,102    104,751    107,703     83,960    148,468    224,318    192,390    213,089    246,844    288,365         602,999
 Net increase /(decrease) in cash           -73,283      1,655    -28,721     54,002     72,376    -31,928     20,699     33,755     41,521     48,440          85,749
Cash and equivilents at end of year        $104,751   $107,703    $83,960   $148,468   $224,318   $192,390   $213,089   $246,844   $288,365   $336,804        $688,748

Appendix C:              Statement of Consolidated Income
                         In 000s’ AUD $

                                           2012 A     2013 A     2014 A     2015 A     2016 A      2017 E     2018 E     2019 E     2020 E     2021 E          2026 E

Revenue                                    $652,351   $897,260 $1,122,542 $1,414,006 $1,338,864 $1,413,840 $1,477,463 $1,536,562 $1,598,024 $1,661,945    $2,022,010

 Cost of Goods Sold                        -609,506   -807,330 -1,028,599 -1,296,439 -1,396,921 -1,320,527 -1,372,563 -1,415,173 -1,469,383 -1,525,666    -1,841,040

Gross Profit                                 42,845     89,930     93,943    117,567    -58,057     93,313    104,900    121,388    128,641    136,280         180,970
 Gross profit margin %                        6.6%      10.0%       8.4%       8.3%      -4.3%       6.6%       7.1%       7.9%       8.1%       8.2%            9.0%

 SG&A                                       -26,268    -51,864    -38,378    -32,294    -62,808    -42,415    -44,324    -44,560    -45,863    -47,199         -54,392

EBITDA                                       32,901     62,575     79,341    109,539    -90,966     75,561     86,793    104,663    112,295    120,347         167,699
 EBITDA margin %                             5.04%      6.97%      7.07%      7.75%     -6.79%      5.34%      5.87%      6.81%      7.03%      7.24%           8.29%

 D&A                                         16,324     24,509     23,776     24,266     29,899     24,662     26,217     27,835     29,517     31,266          41,121

EBIT                                         16,577     38,066     55,565     85,273   -120,865     50,898     60,576     76,828     82,778     89,080         126,578

 EBIT margin %                                2.5%       4.2%       4.9%       6.0%      -9.0%       3.6%       4.1%       5.0%       5.2%       5.4%            6.3%

 Net interest expense                        -4,020    -11,340     -8,421     -4,110     -5,499     -5,853     -5,125     -4,418     -3,742     -3,096            -111

EBT                                          12,557     26,726     47,144     81,163   -126,364     45,045     55,451     72,411     79,036     85,985         126,467
 Profit Margin %                              1.9%       3.0%       4.2%       5.7%      -9.4%       3.2%       3.8%       4.7%       4.9%       5.2%            6.3%

 Income tax expense                          -1,514      9,016    -15,285    -28,007     42,182    -16,796    -19,990    -25,353    -27,317    -29,396         -41,771

 Effective tax rate                            9%        -24%       28%        33%        35%        33%        33%        33%        33%        33%              33%

Net Income / (loss)                         $11,043    $35,742    $31,859    $53,156   -$84,182    $28,249    $35,461    $47,057    $51,719    $56,588         $84,696

   Other comprehensive income                  929      13,450     -6,467     27,624     46,077      7,069      7,387      7,683      7,990      8,310          10,110

Total comprehensive income                  $11,972    $49,192    $25,392    $80,780   -$38,105    $35,318    $42,848    $54,740    $59,709    $64,898         $94,806
 Earnings per share (cents)                    4.54      12.01       9.30      15.38     -24.21       8.13      10.20      13.54      14.88      16.28           24.36

                                                                                                                                                         12
CFA Institute Research Challenge                                                                                                        24 Oct 2016

Appendix D:               Depreciation Schedule
                          In 000s’ AUD $

Debt schedule was used build up approximations for depreciation and capital expenditure for the DCF model through to 2026.
Useful life sourced from annual reports.
                                      2016 A      2017 E    2018 E    2019 E    2020 E    2021 E    2022 E    2023 E    2024 E    2025 E    2026 E

PP&E (beg of year)                                490,798   532,406   521,092   508,785   495,445   481,032   465,502   448,811   430,911   495,445
CAPEX                                   12,793     70,692    14,775    15,366    15,980    16,619    17,284    17,976    18,695    19,442    20,220
 As a % of revenue                         1.0%     5.0%      1.0%      1.0%      1.0%      1.0%      1.0%      1.0%      1.0%      1.0%      1.0%
Useful life
 PP&E Years                                  30
 CAPEX Years                                 10
Depreciation (straight line)
 Existing PP&E                                     16,360    16,360    16,360    16,360    16,360    16,360    16,360    16,360    16,360    16,360
 2017 CAPEX                                         7,069     7,069     7,069     7,069     7,069     7,069     7,069     7,069     7,069     7,069
 2018 CAPEX                                                   1,477     1,477     1,477     1,477     1,477     1,477     1,477     1,477     1,477
 2019 CAPEX                                                             1,537     1,537     1,537     1,537     1,537     1,537     1,537     1,537
 2020 CAPEX                                                                       1,598     1,598     1,598     1,598     1,598     1,598     1,598
 2021 CAPEX                                                                                 1,662     1,662     1,662     1,662     1,662     1,662
 2022 CAPEX                                                                                           1,728     1,728     1,728     1,728     1,728
 2023 CAPEX                                                                                                     1,798     1,798     1,798     1,798
 2024 CAPEX                                                                                                               1,869     1,869     1,869
 2025 CAPEX                                                                                                                         1,944     1,944
 2026 CAPEX                                                                                                                                   2,022

Total book depreciation                $29,899    $23,429   $24,907   $26,443   $28,041   $29,703   $31,432   $33,229   $35,099   $37,043   $39,065

                                                                                                                                            13
CFA Institute Research Challenge                                                                                                                            24 Oct 2016

Appendix E:                Operating Working Capital Schedule
                           In 000s’ AUD $

Operating working capital schedule was used to forecast the changes in working capital for the DCF model. Averages of the 4 years
before the write-down were used to estimate payable, prepaid and turnover days. The write down of work in progress was booked to
inventories, and is the reason for the negative working capital.
                                       2016 A        2017 E      2018 E      2019 E      2020 E      2021 E      2022 E      2023 E      2024 E      2025 E      2026 E

Current Asset
 Trade and receivables                 128,340       121,747     127,226     132,315     137,608     143,112     148,836     154,790     160,981     167,421    174,118
   Days receivable                          31.28      31.00       31.00       31.00       31.00       31.00       31.00       31.00       31.00       31.00       31.00
 Inventories                           108,974       110,044     114,380     117,931     122,449     127,139     132,008     137,064     142,313     147,762    153,420
   Inventory turnover days                  57.81      30.00       30.00       30.00       30.00       30.00       30.00       30.00       30.00       30.00       30.00
 Prepayments                                5,408      2,356       2,462       2,476       2,548       2,622       2,698       2,776       2,856       2,938       3,022
   Days prepaid                          -36.36        20.00       20.00       20.00       20.00       20.00       20.00       20.00       20.00       20.00       20.00
 Derivatives                                 147         141         148         154         160         166         173         180         187         194         202
   % Of revenue                          0.01%        0.01%       0.01%       0.01%       0.01%       0.01%       0.01%       0.01%       0.01%       0.01%       0.01%
Total current assets                   $242,869     $234,289    $244,216    $252,875    $262,764    $273,039    $283,716    $294,810    $306,337    $318,315    $330,762

Current Liabilities
 Trade and other payables              -229,774     -220,088    -228,761    -235,862    -244,897    -254,278    -264,017    -274,128    -284,626    -295,525    -306,840
   Days payable                             58.41      60.00       60.00       60.00       60.00       60.00       60.00       60.00       60.00       60.00       60.00
 Derivatives                            -10,690      -14,138     -14,775     -15,366     -15,980     -16,619     -17,284     -17,976     -18,695     -19,442     -20,220
   % Of revenue                          1.20%        1.00%       1.00%       1.00%       1.00%       1.00%       1.00%       1.00%       1.00%       1.00%       1.00%
 Provisions                             -42,291      -42,415     -44,324     -46,097     -47,941     -49,858     -51,853     -53,927     -56,084     -58,327     -60,660
   % Of revenue                          2.84%        3.00%       3.00%       3.00%       3.00%       3.00%       3.00%       3.00%       3.00%       3.00%       3.00%
 Deferred grant income                   -8,543       -5,655      -5,910      -6,146      -6,392      -6,648      -6,914      -7,190      -7,478      -7,777      -8,088
   % Of revenue                          0.44%        0.40%       0.40%       0.40%       0.40%       0.40%       0.40%       0.40%       0.40%       0.40%       0.40%
 Income tax payable                           -98        -23         -28         -35         -38         -41         -44         -47         -51         -54         -58
   Days payable                        (0.0023)         0.50        0.50        0.50        0.50        0.50        0.50        0.50        0.50        0.50         0.50
 Pre-payments                           -12,812      -29,345     -30,501     -31,448     -32,653     -33,904     -35,202     -36,550     -37,950     -39,403     -40,912
   Days payable                              5.02       8.00        8.00        8.00        8.00        8.00        8.00        8.00        8.00        8.00         8.00
Total current Liabilties              -$304,208     -$311,665   -$324,298   -$334,954   -$347,901   -$361,348   -$375,313   -$389,818   -$404,883   -$420,529 -$436,779

Total operating working capital        -$61,339      -$77,376    -$80,082    -$82,079    -$85,137    -$88,309    -$91,597    -$95,008    -$98,545   -$102,213 -$106,017
 Change operating working capital       196,206       -16,037      -2,706      -1,997      -3,058      -3,171      -3,289      -3,411      -3,537      -3,668     -3,804

                                                                                                                                                                14
CFA Institute Research Challenge                                                                                                                               24 Oct 2016

Appendix F:            Discounted Cash-Flow
                       In 000s’ AUD $

The Unlevered Free Cash-Flows available to the Firm (UFCFF) were discounted back at the WACC of 13.6% to arrive at the net present
value of the cash-flows, $348,160.

                                  2016A         2017E           2018E        2019E         2020E          2021E        2022E        2023E        2024E        2025E         2026E

Net Sales                      $1,338,864   $1,413,840    $1,477,463     $1,536,562    $1,598,024     $1,661,945   $1,728,423   $1,797,560   $1,869,462   $1,944,241    $2,022,010
 % growth                          -5.3%         5.6%            4.5%         4.0%            4.0%         4.0%         4.0%         4.0%         4.0%         4.0%          4.0%
EBITDA                            -90,966      75,561           86,793     104,663       112,295        120,347      128,840      137,798      147,244      157,202       167,699
 % margin                          -6.8%         5.3%            5.9%         6.8%            7.0%         7.2%         7.5%         7.7%         7.9%         8.1%          8.3%
 (-) Depreciation                 29,899       24,662           26,217      27,835        29,517         31,266       33,086       34,978       36,946       38,992        41,121
EBIT                             -120,865      50,898           60,576      76,828        82,778         89,080       95,755      102,820      110,298      118,210       126,578
 % Margin                          -9.0%         3.6%            4.1%         5.0%            5.2%         5.4%         5.5%         5.7%         5.9%         6.1%          6.3%
 (-) Taxes                        -42,182      16,796           19,990      25,353        27,317         29,396       31,599       33,931       36,398       39,009        41,771
 Marginal tax rate                34.9%        33.0%            33.0%       33.0%         33.0%          33.0%        33.0%        33.0%        33.0%        33.0%         33.0%
Unlevered Net Income              -78,683      34,102           40,586      51,475        55,461         59,684       64,156       68,890       73,900       79,201        84,807
 (+) D&A                          29,899       24,662           26,217      27,835        29,517         31,266       33,086       34,978       36,946       38,992        41,121
 (+) Working capital changes     159,161       16,037            2,706        1,997           3,058        3,171        3,289        3,411        3,537        3,668         3,804
 (-) CAPEX                        -12,793      -70,692       -14,775        -15,366       -15,980        -16,619      -17,284      -17,976      -18,695      -19,442       -20,220
Unlevered FCFs                   $97,584       $4,109       $54,734        $65,942       $72,056        $77,502      $83,246      $89,303      $95,688     $102,419      $109,512

Discounted Cash-flows                          $3,617       $42,413        $44,980       $43,267        $40,966      $38,734      $36,578      $34,501      $32,507       $30,597
NPV of UFCFF                   $ 348,160

 Terminal Values:
                Exit Multiple 11x                           Perpetuity growth 2.5%
                     2026E EBIT 126,578                                 2026E FCFF 109,512
              Terminal Value 1,392,356                            Terminal Value 1,011,256
       PV of Terminal Value $389,016                     PV of Terminal Value $282,539

 DCF Value:                                  EBIT Exit                  Perpetuity Growth
 Present Value of Cash Flows                       348,160                       348,160
 Present Value of Terminal Value                   389,016                       282,539
Total Enterprise Values                          $737,176                      $630,699
 Net Debt                                          -51,707                       -51,707
 Share Count                                       347,665                       347,665
Equity Value                                     $788,883                      $682,406
Estimated share price                                   $2.27                         $1.96

                                                                                                                                                                   15
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