XTEK Ltd (ASX:XTE) has secured a Speculative Buy rating from Taylor Collison off the back of its proprietary business lines in the defence sector for body armour (XTclave) and SUAS (XTatlas), which are now being monetised.
The report said the company was in the process of moving from a distributor of military equipment to a manufacturer of its own proprietary products.
“This will have the effect of boosting profit margins and subject to uptake of the products globally, should result in higher and more consistent revenues," it said.
“One or two major contract wins within the body armour space could provide the catalyst for XTE’s shares to re-rate.
“The business is profitable and large new markets are being opened due to past investment in body armour and the strategic purchase of HighCom.”
Demand driven by defence spending
Underlying demand for XTE’s products continues to be driven by defence spending, which has proven resilient to economic cycles despite the current COVID-19 environment.
The report stated: “In order to continue to grow the business, XTE is required to win future defence contracts.
“The purchase of HighCom enables XTE to sell its products to the US military as an American supplier with production from its new US facility.
“Noting the risks associated with investing in XTE given its small size and sale win risks, it is now better positioned, and we consider it a Speculative Buy.”
Contract and distribution agreements
The company recently announced the signing of an exclusive distribution agreement with KeyOptions Pty Ltd, a master agent for Virolens, which is a test that screens for SARS-CoV-2 in around 30 seconds.
The test has been approved by the UK Medical and Healthcare product Regulation Agency and an application for approval has been lodged with the Therapeutic Goods Administration (TGA) in Australia.
Taylor Collison said: “With TGA sign-off VIrolens’ test may play a role when international borders reopen and larger scale testing is conducted."
In regard to other recent agreements, Taylor Collison said: “HighCom has secured approval for a permanent export licence for ballistic products to Mexico City with current exports worth US $2.1 million.
“The signing of a memorandum of understanding with Milrem Robotics (a leading robotics and autonomous systems developer) allows XTE to act as their representative in Australia and New Zealand.”
Trading update and financials
The company’s 1H 2021 inventory is up from $3.2 million in 1H20 to $11.1 million, with management confirming this relates to WIP of a yet to be commissioned manufacturing machine and not a build-up of saleable products.
The machine is expected to be moved over onto the fixed asset register by the end of FY21.
The report stated: “XTE has continued to make progress towards its aim of 75% of units sold being XTE proprietary products and not distribution sales.
“XTE’s revenue and profit is heavily skewed towards the second half of the financial year with the lower sales figures in H1 not a cause for alarm.
“The typical split of total revenue for XTE’s H1 is between 20-35% of revenue.”
Balance sheet and valuation
The company’s balance sheet is well funded with net cash of $9.3 million at December 31, 2020.
The report stated: “The key for XTE is its ability to sell more proprietary products enabling it to start generating positive operating cash flow and justifying a re-rate higher.”