Company Overview: Electro Optic Systems Holdings Limited (ASX: EOS) operates in the sectors of defence, space and communications. It has defence expertise for weapon systems optimisation and integration and has also got ISR capabilities for land warfare. In the space segment, it specialises in applying in-house developed optical sensors to detect, track and classify objects in space and has both military and commercial applications. The company also provides satellite communications services and ensures high speed, efficient communications across the world.

EOS Details

Decent Traction in Top-Line on the back of Strategic Agreements & Alliances: The company has recently reported that it has received its first payment from a major overseas contract and also entered into a strategic agreement with Diehl Defence. Its space segment business unit has developed a new innovative laser technology for space debris mitigation through the use of a Guide Star Laser. EOS developed the IP in collaboration with SERC and will be commercialised and owned by the company.

Receipt of Payment in Defence Systems: The company received a payment of ~$30 million from a major overseas contract during the June 2021 quarter. It recorded total cash receipts of $65.5 million during the quarter ended June 2021. It has increased its investments in the inventory during the March 2020 to March 2021 period in order to meet the demand for strong export orders. It further expects cash receipts of over $100 million from this business in H2FY21.

Agreement of Co-operation with Diehl Defence: EOS has entered into a cooperation agreement with Diehl Defence GmbH & Co KG for commercial collaboration. The initial focus will be on the area of advanced stabilised and remotely operated weapon systems (RWS) for the European and NATO markets. As a part of the agreement, a production line for RWS will be established in Diehl’s German facilities and is expected to bolster the European defence forces, aided by Australian technology.

Formation of the Sovereign Missile Alliance: As per a recent announcement, EOS and Nova Systems have formed the Sovereign Missile Alliance (SMA), a JV with both companies as equal partners. The Commonwealth expects GWEO requirements of over $40 billion to 2040 period, and the selected SIP's will be responsible for executing the projects. The SMA owing to its capabilities, supply chain and industry expertise, will compete for selection as one of the SIP's.

June 2021 Quarter Ended Performance Overview:

The company reported total cash receipts of $65.5 million during the quarter.

• It reported revenues of $13.8 million in H1FY21 from the Communications business unit, compared to revenues of ~$8 million in the prior corresponding period.
• The cash inflows from operating activities stood at $17.32 million during the quarter ending 30 June 2021.
• It ended the period with a cash balance of ~$51.11 million as of 30 June 2021.

Cash Balance Trend (Source: Analysis by Kalkine Group)

SpaceLink Selected for a Funded Demonstration: On 2 August 2021, the company has announced that its subsidiary SpaceLink has been selected by CASIS for a funded demonstration of its end-to-end relay service. The service is expected to provide secure, continuous, high-capacity communications between spacecraft and the ground. The demonstration is expected to validate the use of a 10 gigabit per second optical terminal for voice, video, and data exchange between the ISS and terrestrial users.

Top 10 Shareholders: The top 10 shareholders together form around 21.75% 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 reported a gross margin of 37.1% in FY20. It reported a debt-to-equity ratio of 0.06x in FY20. The total debt stood at $21.1 million as of 31 December 2020, comprising of $17.7 million in long term debt and $3.4 million as short-term debt.

Growth Profile and Liquidity Profile (Source: Analysis by Kalkine Group)

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

• Financial Risk: It is exposed to market risks, which includes currency risk, interest rate risk and price risk.
• Credit Risk: It is prone to credit risks if a counterparty fails to deliver on its contractual obligations or trade receivables.
• Loss from Operations: The company reported a loss of $25.20 million from operations in FY20, reflecting an increase in the COGS and key operating expenses.

Outlook: EOS expects its revenue to be in the range of $235-245 million in FY21, exhibiting a growth of over 30% on FY20. It expects underlying EBIT to be in the range of $20-25 million before SpaceLink costs. It reported order backlog of executed orders at ~$428 million as of 27 May 2021, in revenue terms. The company also expects decent cash receipts going forward and reported potential material contract awards of over $1 billion in H2FY21.

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: The company has appointed Peter Leahy AC as the chair to the Board on 27 July 2021, following the decision of Fred Bart to step down as a Director and Chair of the Board of the company. As per ASX, the stock of EOS is trading below its average 52-weeks’ levels of $3.620-$6.920. The stock of EOS gave a negative return of ~20.26% in the past one year and a positive return of ~5.66% in the past one week. We have valued the stock using an EV/Sales multiple-based illustrative relative valuation and have arrived at a target price of low double-digit upside (in % terms). We believe that the company can trade at a slight discount to its peer average EV/Sales (NTM trading multiple), considering the increase in the cost of goods sold, operating expenses and the uncertain economic environment due to the prevalence of COVID-19 pandemic. For this purpose, we have taken peers such as Orbital Corporation Ltd (ASX: OEC), Austal Ltd (ASX: ASB), Xtek Ltd (ASX: XTE), to name a few. Considering the expected upside in valuation and current trading levels, strategic agreements, optimistic revenue guidance and the key risks associated with the business, we recommend a ‘Speculative Buy’ rating on the stock at the current market price of $4.22, up by 1.69% (as on 03 August 2021, 10:47 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.

---

Disclaimer - This report has been issued by Kalkine Pty Limited (ABN 34 154 808 312) (Australian financial services licence number 425376) (“Kalkine”) and prepared by Kalkine and its related bodies corporate authorised to provide general financial product advice. Kalkine.com.au and associated pages are published by Kalkine.

Any advice provided in this report is general advice only and does not take into account your objectives, financial situation or needs. You should therefore consider whether the advice is appropriate to your objectives, financial situation and needs before acting upon it.

There may be a Product Disclosure Statement, Information Statement or other offer document for the securities or other financial products referred to in Kalkine reports. You should obtain a copy of the relevant Product Disclosure Statement, Information Statement or offer document and consider the statement or document before making any decision about whether to acquire the security or product.

You should also seek advice from a financial adviser, stockbroker or other professional (including taxation and legal advice) as necessary before acting on any advice in this report or on the Kalkine website. Not all investments are appropriate for all people.

The information in this report and on the Kalkine website has been prepared from a wide variety of sources, which Kalkine, to the best of its knowledge and belief, considers accurate. Kalkine has made every effort to ensure the reliability of information contained in its reports, newsletters and websites. All information represents our views at the date of publication and may change without notice.

Kalkine does not guarantee the performance of, or returns on, any investment. To the extent permitted by law, Kalkine excludes all liability for any loss or damage arising from the use of this report, the Kalkine website and any information published on the Kalkine website (including any indirect or consequential loss, any data loss or data corruption). If the law prohibits this exclusion, Kalkine hereby limits its liability, to the extent permitted by law, to the resupply of services.

Please also read our Terms & Conditions and Financial Services Guide for further information.

On the date of publishing this report (referred to on the Kalkine website), employees and/or associates of Kalkine do not hold interests in any of the securities or other financial products covered on the Kalkine website.