Electro Optic Systems — A technology driven defence specialist

Electro Optic Systems (ASX: EOS)

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Research: Industrials

Electro Optic Systems — A technology driven defence specialist

Electro Optic Systems (EOS) is a specialist defence company leveraging its optic technology within specific military applications, primarily remote weapons systems and maritime communications. It is benefiting from growth in global defence spend and, with its latest Counter-Uncrewed Aerial Systems (C-UAS) capabilities, an increase in drone warfare. A new management team, an improved commercial focus and a broadening product portfolio should assist in winning a greater share of these markets, driving growth and profitability.

David Larkam

Written by

David Larkam

Analyst, Industrials

Industrials

Electro Optic Systems

A technology driven defence specialist

Aerospace and defence

Spotlight - Update

29 May 2024

Price

A$1.4

Market cap

A$270m

A$1.90/£

Share price graph

Share details

Code

EOS

Listing

ASX

Shares in issue

193m

Net cash (A$m) at 31 December 2023

6.2

Business description

Electro Optic Systems develops advanced technology products and services for the global defence and space domains. Its core products include remote weapon and counter-drone systems, on-the-move satellite communications and advanced space technologies.

Analyst

David Larkam

+44 (0)20 3077 5700

Electro Optic Systems is a research client of Edison Investment Research Limited

Electro Optic Systems (EOS) is a specialist defence company leveraging its optic technology within specific military applications, primarily remote weapons systems and maritime communications. It is benefiting from growth in global defence spend and, with its latest Counter-Uncrewed Aerial Systems (C-UAS) capabilities, an increase in drone warfare. A new management team, an improved commercial focus and a broadening product portfolio should assist in winning a greater share of these markets, driving growth and profitability.

Consensus estimates

Year
end

Revenue
(A$m)

PBT
(A$m)

EPS
(c)

DPS
(c)

P/E

(x)

Yield
(%)

12/22

138

(62.9)

(35.8)

0.0

N/A

N/A

12/23

219

(40.2)

(20.9)

0.0

N/A

N/A

12/24e

242

(22.5)

(10.5)

0.0

N/A

N/A

12/25e

285

11.0

5.7

0.0

24.5

N/A

Source: LSEG consensus 28 May 2024. Note: *PBT and EPS as reported.

Strong position in niche defence market

EOS has 40+ years of technology development in electro-optics and control platforms which it commercialises primarily within specialist military applications. EOS positions itself as a provider of non-ITAR products, which is appealing to customers outside of the US. The Defence Systems division develops technology for weapon systems optimisation and integration. The key product area is remote weapons systems (RWS) for accurate, rapid firing of kinetic munitions. The latest product incorporates drone defence or C-UAS and has received its first orders. The next generation product developments include high energy laser based systems. The Space Systems division supplies rugged, high up-time satellite communication (SATCOM) systems for navy and the maritime sector as well as specialist space domain data from its own infrastructure and in-house developed optical capabilities.

Significant market opportunities

In response to heightening levels of conflict (Ukraine) and threats (China Sea), defence spend is on the rise. SIPRI reported 9% growth in 2023. Recent conflicts have also witnessed changes in engagement, in particular the rise in the use of drones. Counter-drone defence systems have been based on missiles but these are expensive at US$500k+ whereas drones cost less than US$20k, hence the need for alternative, cheaper counter-drone systems such as RWS operating traditional munitions, offering a high degree of accuracy and speed of engagement.

Restructured and re-platformed

Following a difficult 2022, a new executive management team was appointed. The operations have been restructured to reduce costs and improve efficiency, the balance sheet refinanced and the commercial focus sharpened. The group is now cash generative and embarking on a growth strategy through geographical expansion and extension of the product range to leverage its longstanding IP base. The December 2023 order book stood at A$622m +99%, hence the recent A$35m equity raise to support working capital requirements on long lead items.

History and recent performance

EOS was founded in 1983 through the privatisation of part of the Australian government’s space activities. The business was developed into a specialist defence group and listed on the Australian stock exchange in 2000. After a steady decade or so, the company started to grow rapidly, both organically and through acquisition, most notably the purchase of EM Solutions in 2019 for A$26m. At this point EOS was performing well, with revenues of A$180m and operating margins of c 13.5% in 2019. This changed with the arrival of COVID-19 in 2020. Lockdowns affecting EOS assembly facilities were exacerbated by component shortages while customer sign-off on the group’s largest order with a United Arab Emirates customer affected cash receipts. In addition, the business was investing heavily in developing a space-based optical communication system for satellites, called SpaceLink, with a total of $70m invested. This led to both a deterioration in cash performance and severe stress on the balance sheet.

The solution was to bring in a new management team to orchestrate a turnaround plan. The key new team comprised:

Non-executive chairman: Garry Hounsell, joined in November 2022. He is a chartered accountant and experienced non-executive director.

Chief executive officer and managing director: Dr. Andreas Schwer, joined as president EMEA in 2020 and was promoted to CEO in August 2022. He has over 30 years’ experience in global defence, manufacturing and space, including at Rheinmetall (president and CEO of the Combat Systems division) and chief executive of Saudi Arabia Military Industries (SAMI). He is also non-executive of Titomic (ASX: TTT; additive manufacturing).

Chief financial officer and chief operating officer: Clive Cuthell joined in September 2022. He is an experienced CFO including with Holcim, Nuplex, Rinker Group.

The turnaround strategy has included a range of initiatives:

Restructuring of operations. Management undertook a cost reduction programme with a headcount reduction of over 100, including delayering management and the closure of two facilities, generating c A$25m of annual savings.

Increased commercial focus. The scientific heritage of the business arguably engendered a culture of product development over commercialisation. The emphasis has been re-aligned towards commercialisation assisted by new management at the operational level. The benefits being seen in the cadence of new product introductions as well as the growth in the order book.

Capital discipline. The SpaceLink subsidiary was developing a constellation of medium Earth orbit satellites to create an interspace communications network. With no forthcoming third-party investment, and an estimated requirement of US$240m, the business was placed in administration, eliminating a significant cash drag.

Focus on cash generation. The delayed customer contract payment issues were resolved as new payment terms were negotiated with a key customer. Internally, there is an increased focus on cash and funding projects with realistic short- to medium-term commercial opportunities.

Improve the balance sheet. The group took on A$70m of debt from longstanding equity investor Washington H. Soul Pattinson (WHSP). The subsequently improved cash position has seen the first two tranches (A$47.4m including interest) repaid, with the final tranche (A$52m including interest) due for repayment in October 2025. Gross cash at the end of 2023 improved from A$21.7m at end 2022 to A$71.0m (net debt pre IFRS16 A$51.0m to net cash of A$6.2m). The balance sheet was recently strengthened further through a A$35m equity placing to support working capital requirements, primarily the order of long lead items, for future orders.

These actions have established a stable platform, both financially and operationally, from which the group aims to return to profitability and develop future growth opportunities.

Activity profile

EOS consists of two divisions, Defence and Space.

Exhibit 1: Overview including FY23 divisional results

(A$m)

Defence

Space

Sales

155.4

63.9

Sales growth, y-o-y

47%

100%

EBITDA

0.2

11.8

EBITDA margin

0.1%

18.5%

Key activities

Remote weapons systems including expanded counter-drone capabilities

Specialist satellite communication systems for marine applications

Growth opportunities

High energy directed laser weapon systems

Space orientated military applications

Source: Electro Optic Systems

Defence Systems division

Core products

The Defence business specialises in technology for weapon systems optimisation. The key product areas are RWS. These systems control the firing process of weapons supplied by third parties, enabling the operation of a weapon remotely (eg from inside a vehicle), allowing the operator/soldier to remain a protected environment and offering reduced personnel risk. Such systems are required to be rugged, reliable and easy to use, and able to be integrated into a range of vehicles/weapons. EOS’s expertise is in tracking sensors and software, from the group’s optical heritage, the gimbal to provide stability and integration of the weapons system. Exhibit 2 highlights the current product portfolio. The core product has been the R400, of which over 2,700 have now been deployed. Recent development has extended the range to the lighter end with the R150, launched in 2023, and the heavier calibre end with the R800, launched in 2024. The business has a strong market position, with the key competitor being Kongsberg, which is a longstanding incumbent supplier to the US military.

Exhibit 2: Defence Systems product portfolio

Source: Electro Optic Systems

Recent developments

The latest developments have been focused on the increasing threat from drones and unmanned aerial vehicles (UAVs). The Slinger (Exhibit 3) counter-drone system is based on the proven R400 platform increased to 4-axis multidirectional capability, incorporating radar diagnostics (benefiting from the group’s Space business) and specialist ammunition to provide a range of up to 1km allowing an extended engagement time. The Slinger has won its first order for A$15m from Germany. Successful deployment will provide early endorsement of the system, assisting commercialisation.

Exhibit 3: EOS Slinger system with anti-drone capabilities

Source: Electro Optic Systems

Future opportunities

High Energy Laser Weapon: The company has developed a prototype directed energy system using a 35kW high power laser. This has the potential to engage swarms of drones or can be used for Counter-Rocket, Artillery and Mortar (C-RAM). The company is in advanced negotiations with two potential customers who will help fund the further development and commercialisation of these products. The company intends to develop higher powered lasers over time although, reflecting the likely significant development costs, this is expected to be undertaken in conjunction with a third party.

Space Systems division

Core products

The Space division comprises three activities based on the ability to communicate and integrate space from the Earth’s surface:

EM Solutions is a world leader in satellite communication (SATCOM) systems for navy defence forces and the maritime sector. Its specialist systems are capable of operating in extreme environments while delivering consistent satellite tracking to maintain high levels of connectivity in the X, Ku and Ka frequency bands. The business accounts for c 80% of the Space division’s revenue and is underpinned by a five-year A$200m Australian naval contract. During 2023 EM Solutions revenue grew by 100% to A$55–60m. The business has a standalone EBITDA margin of 33%.

EOS Space Technologies supplies space surveillance and intelligence services data.

KiwiStar Optics, based in New Zealand, specialises in precision optical systems and has designed and installed bespoke lenses and other components for many of the world’s leading space observatories and telescopes.

Exhibit 4: EM Solutions

Exhibit 5: Space technology data collection

Source: Electro Optic Systems

Source: Electro Optic Systems

Exhibit 4: EM Solutions

Source: Electro Optic Systems

Exhibit 5: Space technology data collection

Source: Electro Optic Systems

Recent developments

The current strategy has a highly commercial focus. This includes a strong focus on geographic expansion of EM Solutions products, and extending the product portfolio (ie leveraging the proven and market accepted technology to land systems, naval terminals and submarine terminals).

Future opportunities

The Space Technologies business has potential within the emerging space warfare environment, utilising its accurate earth-to-space laser systems, capable of detecting very small objects in space. The product development opportunity includes using ground-based lasers to disrupt enemy satellites. Clearly this is a longer-term opportunity, requiring significant investment. As is typical in the industry, EOS is seeking funding from third parties including customers and governments.

Market growth

EOS’s business is dominated by the defence market, hence the level of defence spend and the direction determines the opportunities available.

Increasing defence spend

Defence spend globally is on the rise. According to the Stockholm International Peace Research Institute (SIPRI), global expenditure rose 9.0% (6.8% at constant prices) in 2023 to US$2.4tn (compared to UK GDP of c US$3.0tn). This is being driven by a range of factors:

Rise in global conflict. The current conflict in Ukraine and the Middle East along with the Red Sea and Africa is consuming hardware, leading to a direct increase in demand, with additional pressure coming from restocking, particularly in Europe, in order to retain levels of military capability.

Increasing political pressure. Within NATO there is significant pressure from the US, which spends 3.5% of GDP on defence, for other countries to increase their defence budgets. This has seen the UK pledge to increase spending from 2.1% to 2.5% of GDP by 2030 and Germany to increase spending from 1.6% to 2.0% of GDP over time.

Geopolitical tensions rising. Current conflicts and potential flashpoints such as the China Sea have seen the end of the post cold war ‘peace dividend’, leading governments to reassess the importance of defence, including from a domestic political position.

Technology developments

Increase in drone warfare. Recent conflicts have seen a significant increase in the use of drones, due to the greater range, improved accuracy, higher payload capacity and reducing costs, which enable waves of ‘non-returnable’ drones to be deployed. Traditionally, missile technology was used as a defence against incoming drones. Missiles cost over US$500k against US$20k or less for a drone, creating an economic mismatch. In addition, missile launch speeds are limited, affecting their effectiveness, particularly against the latest offensive strategy of drone swarm attacks. This is opening up the market for alternative technologies, such as automated controlled kinetic weapons and non-kinetic engagement using laser or other technology. Note that radar jamming and similar technology is also being used but proving somewhat easier for drone developers to counter.

New technologies/war fronts. The increased use of drones has reignited interest in laser weapons. EOS has expertise in this sector (up to c 50kW) with high-energy laser weapons (HELW) in the market expected to range up to 350kW. EOS clearly has expertise that can be used in developing these weapons, but, given the different laser technology required and the expense, would do so only in partnership or with external funding. Similarly, the space arms race appears to be back on the agenda. The US recently claimed that Russia is developing a weapon with the potential to threaten satellites. The criticality of communications increases the sensitivity of such a move and is likely to see future similar developments by other parties. EOS’s expertise in detection in space and data gathering should provide opportunities, albeit these are likely to be long term and, given the likely expense, to require external funding.

Exhibit 6: Financial summary

Year end 31 December

A$m

2020

2021

2022

2023

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue

 

 

180.2

212.3

137.9

219.3

Cost of Sales

(116.0)

(111.6)

(91.4)

(123.7)

Gross Profit

64.2

100.8

46.5

95.6

Admin & other costs

(67.1)

(98.7)

(89.4)

(88.7)

EBITDA

 

 

(2.9)

2.1

(42.9)

6.9

Depreciation & amortisation

(9.6)

(11.8)

(11.1)

(12.4)

Operating profit (before amort. and excepts.)

 

 

(12.5)

(9.7)

(54.0)

(5.5)

Exceptionals

(16.0)

8.0

5.4

0.9

Reported operating profit

(28.5)

(1.7)

(48.6)

(4.6)

Net Interest

(1.4)

(2.9)

(14.3)

(35.6)

Profit Before Tax (norm)

 

 

(13.9)

(12.6)

(68.2)

(41.1)

Profit Before Tax (reported)

 

 

(29.9)

(4.6)

(62.9)

(40.2)

Reported tax

4.7

(9.2)

9.3

6.1

Profit After Tax (reported) - continuing businesses

(25.2)

(13.8)

(53.6)

(34.1)

Discontinued operations

0.0

0.0

(62.0)

0.0

Reported profit for the year including discontinued operations

(25.2)

(13.8)

(115.6)

(34.1)

EPS - basic reported (c)

 

 

(19.5)

(10.0)

(35.8)

(20.9)

BALANCE SHEET

Fixed Assets

 

 

130.7

173.4

155.7

173.7

Intangible Assets

34.6

32.0

24.8

30.6

Contracts & deposits

30.3

48.6

72.1

84.9

Tangible Assets

29.1

56.1

37.2

29.5

Investments & other

36.7

36.7

21.6

28.7

Current Assets

 

 

306.6

284.8

261.6

219.5

Stocks

67.3

74.6

74.8

73.4

Debtors

35.8

23.5

7.4

8.5

Contracts & deposits

137.6

127.2

145.5

50.2

Cash & cash equivalents

65.9

59.3

21.7

71.0

Other

0.0

0.2

12.2

16.4

Current Liabilities

 

 

70.8

96.9

104.8

115.5

Creditors

52.2

35.4

43.2

40.8

Short term borrowings including finance leases

0.0

34.4

23.3

19.9

Other

18.6

27.1

38.3

54.8

Long Term Liabilities

 

 

27.0

31.9

79.5

78.6

Long term borrowings including finance leases

17.7

24.7

69.9

63.9

Other long term liabilities

9.3

7.2

9.6

14.7

Net Assets

 

 

535.1

587.0

601.6

587.3

Minority interests

Shareholders' equity

 

 

535.1

587.0

601.6

587.3

CASH FLOW

EBITDA

(2.9)

2.1

(42.9)

6.9

Working capital

(110.2)

22.2

(15.2)

113.1

Exceptional & other

24.1

(21.8)

7.5

(23.6)

Tax

(12.0)

(2.6)

(1.0)

16.7

Net Operating Cash Flow

 

 

(100.9)

(0.2)

(51.6)

113.1

Investment activities

(7.3)

(8.7)

(11.2)

(31.8)

Capex

(29.7)

(29.0)

(19.3)

(2.9)

M&A/Other

0.0

0.0

2.2

0.0

Equity financing

138.6

(0.8)

14.6

0.0

Other

0.0

0.0

0.0

(4.1)

Net Cash Flow

 

 

0.7

(38.7)

(65.3)

74.3

FX

(3.3)

31.1

34.9

(29.0)

Other non-cash movements

(9.4)

1.0

(7.2)

4.0

Closing (cash)

 

 

(65.9)

(59.3)

(21.7)

(71.0)

Closing net debt/(cash) excluding finance leases

 

 

(65.9)

(24.9)

51.0

(6.2)

Source: Electro Optic Systems accounts

General disclaimer and copyright

This report has been commissioned by Electro Optic Systems and prepared and issued by Edison, in consideration of a fee payable by Electro Optic Systems. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

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General disclaimer and copyright

This report has been commissioned by Electro Optic Systems and prepared and issued by Edison, in consideration of a fee payable by Electro Optic Systems. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2024 Edison Investment Research Limited (Edison).

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Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

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This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

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In its pre-close FY24 trading update, Accsys stated that trading in Q424 was better than expected and cost saving measures are on track to deliver more than €3m annually. Management now expects adjusted group FY24 EBITDA to be higher than consensus of €2.5m. It also commented that the construction of the Accoya USA plant is still on track to begin commercial operations in mid-2024 and it is committed to make a decision on the Tricoya project in the UK in H125. On higher estimates, our discounted cash flow (DCF) points to a value per share of €0.96 (previously €0.86).

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