Going defensive: two small caps with military links
Independent Investment Research
For two small caps exposed to the industrial military machine here and in the US, increased defence and anti-terrorism spending is a godsend...
Xtek (XTE) 50c
For a company that promotes itself as a homeland security specialist, life should be rosy as authorities spend up big on anything from protective bollards to bazookas.
As if we don’t need reminding, the urgency of the threat has been highlighted by the federal government’s decision to create an uber national security ministry.
But for the Queanbeyan-based Xtek, sustained profitability has proved elusive over its 12 years as a listed company.
“The problem with defence (procurement) is that it’s feast or famine,’’ says Xtek chief Philippe Odouard. “A small company like us spend a lot of time promoting a product with a pipeline of several years.”
After years of sporadic orders for its products that include armour plating, helmets, bomb-disposal equipment, Xtek has landed the big one: a $100m order from the Department of Defence to supply and maintain a fleet of SUAS (small unmanned aerial systems, or drones).
Put in context, Xtek turned over a measly $3m last year.
Xtek is the exclusive local agent for AeroEnvironment of the US, the world’s biggest drone maker.
Xtek, however, is not just clipping the ticket on AeroEnvironment’s machines. More than half of the value of the order consists of ongoing servicing of the units (which, while sturdy can take a battering in the field), training the users and providing software that enhances the drones’ aerial pics.
As a guide to how long it’s taken to get the military on side, Xtek was involved with trialling unmanned vehicles for the navy a decade ago.
US military heavies are also testing Xtek’s ability to make stronger but lighter helmets and armour with its curing process called XTclave. The US Army has carried out ‘foreign comparative testing’’ on Xtek’s armour plating, which determines whether kit is better and no dearer than that of a preferred apple pie American supplier.
A meeting is scheduled for October but according to Odouard “they are quite happy with the results.”
The Marines have also bought $800,000 of helmets made with a hydro-clave process that involves the headwear being moulded with high-pressure oil.
Xtek’s belated progress hasn’t gone unnoticed by the market, with the stock bounding 38% (to a high of 55c) after the June 1 drone announcement.
The company has also guided to $9m of revenue for 2016-17, building to $11-20m in the current year.
Not to waste the opportunity, Xtek on June 28 launched a $3m placement and a $500,000 share purchase plan at 46c apiece, a then 16% discount to the prevailing price. “We have started communicating this to the market and this has changed the profile of the company to a production story,’’ Odouard says.
Odouard previously headed the carbon composities specialist Quickstep Holdings (QHL). A supplier of parts for the F18 joint strike fighter and Hercules transport planes, Quickstep has experienced a similar snail-like trajectory.
Under Odouard, Xtek has sharpened its focus to military contracts and has shut down a cash-sapping retailing business that’s old hunting rifles and revolvers.
“It was eating a lot of cash in no-one really understood properly.”
Indeed: two good reasons to exit a business.
Alexium International (AJX) 55c
Along with Quickstep, Xtek cites ship builder Austal (ASB), marine propulsion outfit Veem (VEE), weaponry and aerospace play Electro Optic Systems (EOS) and drone surveillance outfit D13 (D13) as listed homeland security peers.
We’ll also throw in the Perth based innovator in flame-retardant (FR) materials, which is targeting the US military complex in relation to uniforms treated with its non-toxic brew that changes the surface properties of materials.
But Alexium’s recent revenue traction stems from its involvement in a ‘softer’ market: comfy mattresses and pillows.
As with so many tech juniors, Alexium’s progress has been a slow burn (pardon the pun) since the stock back door listed in 2010 at 20c apiece.
Originally, investor excitement centred on Alexium’s ambition to supply the US military with uniform retardant.
“Progress is always slow to break into the defence sector unless there is an immediate unmet need ,’’ says Alexium chairman Gavin Rezos.. “The reason is the size and value of the orders and the supply chain changes warrant extensive testing to ensure best product, cost effectiveness and robust supply chain.”
In the meantime, Alexium has targeted a number of industrial markets, including a deal with an unnamed large mattresses maker.
There’s nothing new about FR treatments. The trouble is, most of them are based on highly toxic bromides, blamed for illnesses including thyroid cancer and memory loss. They’ve been banned (or are the process of being outlawed) in most western countries.
Alexium recently reported record shipments of Alexicool in the month of June of 90,000 pounds, more than five times the run rate in January.
Alexium cites the FR market as a $US7bn global opportunity. Other applications include transportation (such as aircraft seats), decorative fabrics and outdoor fabrics. Another is fireproofing electric components, such as circuit boards.
Another use is coating technology for building materials, including cladding. If anyone doubts the potential there, look no further than London’s cladding-related Grenfell Tower fire that killed at least 79 people.
In the meantime, Alexium maintains the US military market is a “strong focus”, especially given President Trump’s intent to boost the number of battle-ready troops.
Rezos says the US Department of Defence is after a more cost effective and non-toxic retardant on nylon-cotton uniforms to replace the existing cotton-rayon garb, for use by all staff rather than just combat troops.
Alexium has been working with Natick (the US Army Research Center) and the US Marines, along with a prime contractor that currently supplies the uniforms.
Testing to date shows Alexium’s FR meets their standards and is cost effective.
Rezos says: “once we sell to US Army and US Marines, the other US armed forces and 22 other militaries (such as NATO) will be able to buy without the need for the same level of testing.”
In the March quarter, Alexium reported revenue of $6.47m, cash outgoings of $5.36m and a cash balance of $6.4m.
The June quarter report, due out next week, should show the company in a cash-flow neutral position (on a run-rate basis).
While Alexium shares have rebounded from their May low of 47c after the June update, investors in the main have been snoozing. But if the company gets its intended Nasdaq listing away, a wider audience might take a different view.
Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.
2 stocks mentioned
Many readers will remember Boreham as author of the Criterion column in The Australian newspaper, for well over a decade. He also has more than three decades’ experience of business reporting across three major publications.