In my previous post I mentioned the impact management can have and how taking a longer term view can be profitable. In Quickstep (ASX: QHL) there is a situation where a change of management might have provided a positive catalyst for a change in the long term value of the business.
Quickstep started in 2001 as an R&D company out of WA to commercialise their patented Qure process for composites manufacturing. The technology is valuable as it provides a way for fast curing of composites compared to the more traditional autoclave based manufacturing. Additionally, it has other advantages such as greater design flexibility, reduced capital investment and other cost savings.
In 2011, Quickstep confirmed a large contract to supply the F-35 joint strike fighter (JSF) components worth an estimated $700m for the next 20 years. It was a long time in the making with the F-35 JSF memorandum of understanding (MOU) signed in 2009. With the JSF contract, Quickstep established a Bankstown manufacturing factory from an old Boeing factory to access pools of skilled labour. In the following years, Quickstep have gone on to win other aerospace defence contract including:
- C-130J & LM-100J wing flaps production. Valued at USD 75-100m value over 5 years to 2019, with strong expectations to continue after this period
- JSF Vertical Tail program for BAE Systems and Marand Precision Engineering. Valued at $139m over life of program
Quickstep has also targeted automotive and niche application of carbon composite, supplying Ford for their carbon-fibre intake system on the XR6 and Micro-X (portable x-ray) for their carbon fibre chasis. Recently, Quickstep has grown to 220 FTE.
Quickstep had great expectations ever since it won the large defence aerospace contracts. It has to do with the nature of those contracts. They are long term, high valued and extremely visible contracts. The contracts largely locked in a staggered step increase in revenue for Quickstep. Importantly, these are signalled as high quality contracts that promises a healthy margin.
Disappointingly, Quickstep has not delivered on its promises. Although revenue did increase as expected, the contracts has not helped it to get to profitability. Part of the reason was perhaps the lack of coherent strategy of successive management teams. Quickstep was not yet ready to fully embrace its manufacturing status and was still confused how its R&D roots will help. It seemed as if Quickstep stumbled to win those huge contracts and then scrambled on to find a coherent strategy to implement and build on top of its defence work.
Now, you might ask…this seems like bad news! That might be right, the share price performance certainly thinks so. The share price is near its all-time low. However Quickstep offers a clear example where past performance may not equal future performance. It highlights the importance of turning over stones in seeking investment ideas rather than relying on multiples.
The current phase, and hopefully brighter phase, was marked (pun intended) by the efforts of the new CEO, Mark Burgess. A steadying hand at the helm was needed as he became Quickstep’s third CEO in the past 3 years. Mr Burgess background includes stints at BAE Systems and most recently as VP APAC for Honeywell Aersopace. As expected for a new CEO, he conducted a strategic review resulting in “OneQuickstep”. His strategic review built on what Quickstep had, narrowing its focus on targeting the aerospace market. His review is also welcoming for the mere fact that he emphasised profitability for Quickstep to be successful. A background to this: Quickstep has never been profitable in its history.
Mr Burgess has announced some encouraging things. The first cab off the rank was Quickstep’s R&D program. The R&D program will be refocused to emphasise on commercial use and will be reduced by $2.7m in FY18, representing ~5% of revenue. Quickstep has also announced that it will streamline its board composition, reducing 3 board members to save ~$220k.
OneQuickstep program has also indicated that it will seek productivity and efficiency programs. This area will be the most crucial for a manufacturing company, and it will not be an easy program to implement. It takes on greater importance for Quickstep as long term contracts usually feature margin compression clauses to account for greater efficiency as manufacturer becomes more familiar with the production requirements. It will not be easy, I have had first-hand experience as a management consultant of how difficult and time consuming it can be. However, saying that productivity improvement can be profound and non-capital intensive if done right.
Optionality in Quickstep
Alas, solely relying on the CEO and his management team to create value doesn’t provide a strong thesis. I am not an expert judgement of character nor am I experienced enough as an investor to be right about characteristics of great management.
What is interesting is the optionality that Quickstep provides on top of what looks like a dependable management team. Quickstep has a base of predictable and significant step up in revenue from what should be a good-margin contract. Existing contracts are expected to deliver $90m revenue by FY21. Management has signalled that significant capex has been mostly been done and it has 30% spare capacity at its Bankstown facility. Thus, it has potentially significant revenue from its non-defence customers with low additional capex.
It also doesn’t hurt that expectations have gotten so low.
Significant risks are still present
There are significant risks to Quickstep. The most obvious risk is execution risk. As I have earlier said, manufacturing can be a fickle thing. The cost of production may not be tamed in the time frame that management expects. This can then undermine the existing management’s efforts. There are a lot of things that can go wrong. It is thus imperative that expectations are tempered and required time provided for Mr Burgess to implement his strategy.
Additionally, there is the risk of the lumpy contracts/MOU being postponed or even cancelled. While this risk might be small due to increasing global defence spending, it still presents a risk.
Not a quick turnaround
Quickstep’s new strategy will require time to play out. I’m thinking about 2 years at the very least. There is likely to be hiccups and unexpected challenges. Company culture is not a quick thing to change (unless you’re Satya Nadella). It is fortunate that Soul Patts, a noted long-term institutional investor is its biggest shareholder. Their stance with TPG has signalled that they are in it for the long term.
Nonetheless, Quickstep looks interesting. With capable management and a bit of luck, they might be cleared for take-off.
Disclosure: I own QHL shares. Nothing here is advice