Company Overview: Electro Optic Systems Holdings Limited (ASX: EOS) has expertise in technology and serves clients from the sectors of defence, space and communications. The company’s defence unit specialises in technology for weapon systems optimisation and integration and also provides ISR (Intelligence, Surveillance and Reconnaissance) for land warfare. EOS Space Systems develops optical sensors to detect, track and classify objects in space. The communications business unit supports and delivers global communication services and systems.

EOS Details

Decent Revenue Forecasts in FY21 with Contract Wins & Conversion of Pipeline Orders: The company has updated that its production facilities in Australia continue to operate as essential services despite the impact of the ongoing COVID-19 pandemic. The company believes that the increasing geopolitical tensions are driving nations to bolster their defence systems and increase their defence spending.

Orders from NATO Navies:

EOS’s subsidiary EM Solutions has received an order to supply its new 2-metre Fleet Satellite Communications Terminals to three NATO navies.

• The contracts have been valued at over $15 million and are expected to deliver terminals for several European frigates and warships during the 2022 and 2023 period.
• This development expands EM Solutions’ backlog and posts a decent growth in the order book.

Performance Overview of H1FY21:

EOS reported decent revenue growth during the period despite COVID-19 disruptions in the economy and its operations.

• Revenue increased by ~29.7% to $97.8 million in H1FY21, compared to $75.4 million in H1FY20. The growth was driven by an increase of 25% in the defence sector revenues to $83.2 million owing to a major overseas contract.
• EBIT improved by ~58% to negative $7.6 million in H1FY21, compared to negative $18.2 million in H1FY20.
• There has been a turnaround in the operating cash flow performance with positive operating cash flows of $4.6 million during the period, compared to a cash outflow of $62.6 million in H1FY20.
• It ended the period with a comfortable cash position of $51.11 million and a debt of $27.5 million on the balance sheet as of 30 June 2021.

Trend in revenue (Source: Analysis by Kalkine Group)

Update on SpaceLink:

• The company's subsidiary, SpaceLink’s independent architecture review has been concluded, and the design phase has been optimised with four satellite constellations yielding improved technical performance and economics.
• It has awarded contracts to Mynaric and Blue Marble for Optical Inter Satellite Links (OISLs).
• SpaceLink plans to award space segment contract and start construction in Q3FY21. It anticipates to convert customer MoUs to commercial contracts from Q4FY21.

Top 10 Shareholders: The top 10 shareholders together form around 21.89% of the total shareholding, while the top 4 constitute the maximum holding. Greene (Benny Allan) and Washington H Soul Pattinson and Company Ltd are holding a maximum stake in the company at 5.29% and 4.62%, respectively, as also highlighted in the chart below:

Top 10 Shareholders (Source: Analysis by Kalkine Group)

Key Metrics:  The company has reported an improvement in the gross margin to 42.3% in H1FY21, compared to 32% in H1FY20. Asset turnover ratio increased to 0.23x in H1FY21, from a level of 0.20x in H1FY20.

Profitability Metrics and Liquidity Profile (Source: Analysis by Kalkine Group)

Key Risks: The company is exposed to the following risk factors:

• Foreign Currency Risk: Its line of operations makes its prone to the risk of foreign currency fluctuations as it has exposures to USD, as well as Singapore dollars.
• Technology Risk: The company deals with high end technologies in order to deliver cutting edge products and services to its clients. Any challenge on the technological front might impact the profitability of the company.
• Inventory Risk: The Group has large amount of inventories on its balance sheet and has reportedly high inventory days, which might impact on its ability to realise cash from its operations at a brisk rate.

Outlook: EOS has already received $30 million from the customer of a major overseas contract and expects over $100 million of cash flow from contract asset in H2FY21. SpaceLink has been awarded an initial contract to deliver a demo on International Space Station, and additional contracts are expected in the near future. The company also expects to close most of the ~$1 billion of contract award in the negotiation phase with customers in Q4FY21. It has revised its guidance levels and estimates revenue to be in the range of $230 million to $240 million in FY21, compared to $235 - $245 million reported previously.  

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

Source: Analysis by Kalkine Group

*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks.

Stock Recommendation: As per ASX, the stock of EOS is trading below its average 52-weeks’ levels of $3.290-$6.920. The stock of EOS gave a negative return of ~27.09% in the past three months and a negative return of ~9.59% in the past one week. The stock has been valued using an EV/Sales multiple-based illustrative relative valuation method and arrived at a target price of low double-digit (in percentage terms). The company might trade at a slight premium to its peers’ average, considering the sales being skewed in H2FY21, expected conversion of the pipeline into orders and optimistic long-term outlook. For the purpose of valuation, few peers like Orbital Corporation Ltd (ASX: OEC), Austal Ltd (ASX: ASB), PTB Group Ltd (ASX: PTB) have been considered. Considering the expected upside in valuation & current trading levels, impressive growth in revenues in H1FY21, recent orders from NATO, decent pipeline of opportunities and the key risks associated with the business, we recommend a ‘Speculative Buy’ rating on the stock at the current market price of $3.31, (as on 21 September 2021, 10.00 AM (GMT+10), Sydney, Eastern Australia).

EOS Daily Technical Chart, Data Source: REFINITIV

Note 1: The reference data in this report has been partly sourced from REFINITIV

Note 2: Investment decisions should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the analysis has been achieved and subject to the factors discussed above alongside support levels provided.

Technical Indicators Defined: -

Support: A level where-in the stock prices tend to find support if they are falling, and downtrend may take a pause backed by demand or buying interest.

Resistance: A level where-in the stock prices tend to find resistance when they are rising, and uptrend may take a pause due to profit booking or selling interest.

Stop-loss: It is a level to protect further losses in case of unfavourable movement in the stock prices.

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