As a global leader in AIS, an advanced identification communications technology used to track and monitor maritime vessels, SRT Marine Systems (SRT:41p) is now fulfilling the potential that first enticed investors to back its IPO on Aim in November 2005.
SRT’s transceivers enable real-time data communication between multiple marine entities, such as vessels, buoys and coast stations, and facilitate a wide range of functionality, such as vessel identification and status, vessel safety, search and rescue, and environment monitoring. They are sold through a global network of value-added resellers (electronics dealers and distributors) who target commercial and leisure vessels in Europe and North America under SRT’s own brands. The company also supplies AIS modules to third-party original equipment manufacturers (OEMs) including Raymarine, Koden and Transas. With over 30 years’ expertise in this area, SRT has a reputation for delivering cutting-edge technology based on a deep domain knowledge and one that has created a high barrier to entry.
The plan is to grow the transceivers side of the business organically at 10 per cent a year by expanding the distribution network, launching new products (a new range was released earlier this month), and through marketing initiatives and special projects with partners. In this week’s half-year results, the company hit that sales target, growing half-year revenues by 10 per cent to £3.5m on a healthy gross profit margin of 38 per cent. Key demand drivers are the voluntary adoption of the technology by leisure and commercial vessel owners, improved sales distribution, and greater market recognition of the quality and performance of the product range.
However, the key reason why analysts at house broker FinnCap expect SRT to report record revenues and profits in the 12 months to 31 March 2020 is down to a sea change in trading prospects in the company’s systems business, which provides integrated maritime surveillance and management systems to coastguards, fishery and other maritime agencies.
|SRT's gross margin underpins higher profits as business scales up|
|Financial year to 31 March||Revenue||Gross profit||Gross profit margin|
|and supports step change in operating profits....|
|Financial year to 31 March||Revenue||Operating profit||Operating profit margin|
|Source: SRT Marine Systems annual report and accounts & FinnCap forecasts|
Each system varies in exact configuration and scale, but at the heart is SRT’s state-of-the-art GeoVS systems application, which enables multiple system users to display, analyse and manage large amounts of real time and historical data derived from extensive satellite and terrestrial networks. For instance, the system enables coastguards to automatically detect and manage potential threats, and fishery authorities to detect illegal, unlicensed and unregulated (IUU) fishing on a national scale.
Philippine government contract a game changer
Key to the transformation in trading prospects is the game-changing contract, worth £31.8m at current exchange rates, with the Philippine government to deliver a vessel management system (VMS) configured for fisheries monitoring and management. Announced in December 2018, the contract is being executed over a four-year period in two main phases.
Phase one involves the supply and commissioning of all the equipment and systems across a network of 132 coast stations, two data centres, 17 monitoring centres, and 5,000 vessel transceivers. This phase is worth £30.8m and is spread across eight milestones of various values over a period of 14 months to deliver and implement the physical system itself.
The system will enable the Philippine authorities to efficiently track, monitor and manage the activities of fishing vessels in real-time without range limitation and to comply with international, regional and national regulations. The SRT VMS system fuses large amounts of data from multiple sensor systems such as AIS, radar, optical, environmental and sources – terrestrial and satellite – to create a high-quality raw data set in a dedicated local data centre that runs the company’s GeoVS-HUB™ network and data management application under the full control of the end customer. The data is then mobilised by operators using special work stations equipped with SRT’s specialist GeoVS-VIEWER™ application.
Milestone revenues due in the second half from the Philippine contract, and ongoing transceiver sales, explain why chief executive Simon Tucker is comfortable that SRT will produce a record second-half trading performance to lift full-year revenue from £20.6m to £30.4m in the 12 months to 31 March 2020, as house broker FinnCap predicts. On this basis, analysts expect SRT to deliver a record annual pre-tax profit of £4m, up from £3.5m in the 2018/19 financial year.
End user demand growing
It’s well worth noting that the Philippine contract, the largest Marine Domain Awareness (MDA) contract of its kind in the world, could be easily expanded from the initial requirement of 5,000 of the country’s fisheries largest vessels to include tens of thousands of medium and small fishing boats, as well as the seamless integration with other relevant maritime authorities.
Indeed, SRT is in discussions on additional contracts with separate government agencies and ministries in the Philippines worth around £160m. They are not the only major contract opportunities, either. Chairman Kevin Finn notes that the six specific projects the company is targeting in the near term in Southeast Asia and the Middle East have an aggregate value of £300m (previously £212m) and are nearing the point of contract. Each project has its own delivery timescale, varying from six months to four years.
|SRT Marine Systems revenue by geographic region (2018/19)|
|Other non-UK territories||1.8|
|Source: SRT Marine Systems 2019 Annual Report|
As well as the near-term pipeline opportunities, SRT has a number of longer-term validated potential contracts worth £280m (previously £200m), ranging in value from less than £1m to £150m and with gross profit margins between 28 per cent and 72 per cent depending on the complexity of the work involved. In aggregate, the total potential validated systems opportunity is worth £580m, mainly with government entities and driven by a combination of national security and fisheries management concerns, and regional regulations such as the EU Fish Catch Certification and the IUU programme.
True, the nature of these system contracts, typically being government projects of significant size and complexity requiring extensive planning and preparation by the end customer, means that they take considerable time to reach the point of contracting. As a result, forecasting exact contract start dates is impossible.
Also, SRT doesn’t have the market all to itself as there are rival producers of AIS transceivers, although only Alltek Marine, a subsidiary of Alltek Technology Corp, an Asia Pacific communication solution provider listed in Taiwan since 2004, provides a complete range of AIS devices. Other AIS suppliers include JRC from Japan, which specialises in Class A devices for big commercial ships; Weatherdock AG, a private German company founded in 2003, which focuses on the cheaper Class B and search and rescue transceivers (SART) devices; Vesper Marine of New Zealand; and ICOM in the UK, which supplies Class B devices. Florida-based ACR/ARTEX supplies emergency and survival equipment so is only focused on the SART segment of the AIS market.
Exploiting an opportunity in marine domain management
That said, the real opportunity for SRT lies in exploiting the increasing opportunities across the globe for the adoption of sophisticated large-scale fisheries vessel monitoring and management systems (VMS) and integrated coastguard surveillance command and control marine domain management (MDM) systems. SRT’s directors have also identified new opportunities in areas such as environment monitoring. The plan is to develop a dedicated sales division to tap demand in this area and use its core SRT-MDA system with customised configuration to deliver a robust and innovative solution.
It makes sense to do so because MDM is likely to have the largest market share in the marine safety market in the coming years as end users such as authorities, transport and shipping organisations adopt advanced surveillance and tracking solutions for better safety and security of the maritime business. The maritime security service market is driven by factors such as ungoverned marine regions, increased awareness about maritime security, and use of advanced and integrated technologies and solutions.
Importantly, AIS has become a critical path identification technology that is an integral sensor system in MDA systems for ports, waterways, coastal surveillance and fishery management. That’s because while radar shows where a vessel is located, AIS technologies offer far more insight, giving greater detail without visual inspection, and providing information in radar shadows, and without loss of targets in sea, rain and snow. SRT’s position in AIS gives the company a strategic position in the MDA market, and one that can be leveraged through its innovative GeoVS maritime display, data analytics and management system. In effect, it is selling ‘Big Data’ systems for the marine environment. For example, highlighting a vessel will reveal its ownership, next of kin, where it’s been for the past few weeks, its licence and owner’s address.
Admittedly, there are a number of large defence and surveillance companies supplying largescale/national MDM systems. These include Raytheon, Saab, Lockheed Martin, Signalis (Airbus), Elman, Selex (Finmeccanica/Leonardo) and Harris, which has partnered with exactEarth to deliver satellite-based AIS solutions. However, defence companies supplying these systems look to build high-value weapons-system sales into the packages, whereas SRT only provides civil defence and security systems. Furthermore, larger defence groups do not match SRT’s specific AIS domain expertise on the civil side, which the company is exploiting by targeting national government contracts specifically in large-scale fisheries monitoring and management systems and integrated coastguard surveillance.
The uncertain global geopolitical backdrop is another driver of demand for SRT’s maritime surveillance and monitoring systems across national security, border control, search and rescue and fisheries management. Governments in Asia and the Middle East now have a preference for autonomous systems rather than those supplied by third-party nations, and there is increasing recognition of the need for day-to-day management of civilian maritime activities given heightened security risks in the region. The rise of nationalism and protectionism is another reason for national governments to increase their control and security of economic zones, including coastal and fishing waters, as are migrant and immigration concerns. This can only add weight to the case for the adoption of SRT’s MDA systems.
Funded for profitable growth and high operational leverage
The game-changing Philippine contract award could just be the tip of the iceberg for SRT. If the company lands any one of the aforementioned six contract opportunities in its £300m near-term bid pipeline, then this would have a transformational impact on profits. That’s because a fixed annual operating cost base of £9.5m could support £100m of annual contract revenue at a 40 per cent gross margin over a three-year period, so a high percentage of incremental gross margin earned will be converted into operating profit and lead to material pre-tax profit and earnings per share (EPS) upgrades.
Indeed, the near-term bid pipeline could generate cumulative operating profit of close to £90m, a huge sum in relation to the £3.4m operating profit SRT reported on revenue of £20.6m in the 2018/19 financial year, and the £4m operating profit forecast by analysts at FinnCap for the 12 months to 31 March 2020. That’s serious operational leverage.
Importantly, SRT has the funding in place to support such a step change in revenue and profits, having raised £7m of new equity through share placings in May 2018 and January 2019. The directors also refinanced debt facilities and have a three-year loan note facility of £10m in place (£6.2m drawn down at 30 September 2019) at an annual interest rate of 8 per cent. This may seem a tad on the high side, but interest costs are tax deductible and the post-tax interest charge is well below cost of equity.
At the end of September 2019, SRT had cash of £1.7m on its balance sheet and since the half-year end has received £4.9m of the £14.3m trade receivables outstanding, so effectively has around £10m of free cash and untapped credit facilities to deliver on the aforementioned six major contracts in its near-term bid pipeline. Current assets of £20.4m are four times higher than current liabilities of £5m, highlighting a strong liquid ratio.
Valuation and target price
Based on a normalised tax charge, SRT’s shares are rated on 21 times earnings estimates, a small discount to the average of FinnCap’s Tech40 index. However, the case for making an investment in SRT is predicated on the company converting its near-term pipeline into firm orders so that the operating leverage of the business really kicks in.
In fact, SRT could be making annual pre-tax profit of £25m to £30m in the coming years, assuming that the company lands the major contracts in its near-term £300m sales pipeline. That level of profitability not only supports the conservative target price of 55p I outlined in my August Alpha Report, to value the company’s equity at £85m, but significant further upside, too. Strong buy.
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