Some of you would have remembered the terrible Concorde Crash on 25 July 2000 where Air France Flight 4590 met with an accident while departing from Paris airport. The accident was attributed to a titanium alloy strip left behind on the runaway from the previous departing Continental Airlines DC-10. This strip was not removed as an originally scheduled runway inspection was not carried out. This “preventable” accident caused 113 fatalities. (Source: http://en.wikipedia.org/wiki/Air_France_Flight_4590)

How can the above accident be prevented? With Stratech’s iFerret system, the debris would have been spotted, removed and the accident would have been prevented. Their system seems to be superior to the other incumbents and have garnered recognition from various large airports.

After looking into the company, I decided to email Stratech to request for an exclusive meeting with Dr David Chew, Executive Chairman of Stratech. To my pleasant surprise, Dr David promptly replied (even though he was overseas) and agreed to an exclusive meeting.

Below are my key takeaways

Foreign object debris is potentially a US$67b market

There are more than 7,400 IATA registered commercial international airports around the world with an estimated US$67 billion market solely on Foreign object Debris (“FOD”) Detection Systems for runways. In addition, such FOD contracts have a maintenance portion where there is recurring revenue equivalent to about 10% to 15% of acquisition cost for the maintenance every year.

Moreover, according to Stratech’s management, this figure of US$67b could increase by at least 50% if other airfield surveillance capabilities are included.

FOD market is just taking off

Previously, there were no technology or / and financing for FOD market. The practice of manual FOD sweeps two to three times a day is inadequate and inefficient. With the issue of FAA Advisory Circulars (“AC”) in Sep 2009 & Sep 2010, 3 fixed base and one mobile FOD Detection systems / technologies were certified.

Table 1: Four systems certified by the FAA

Source: Various, FAA, Philip SecuritiesFinancing mechanism / Funding is made available through the AIP (Airport Improvement Program) & PFC (Passenger Facility Charge). The catch is that for airports who wish to utilize the above grants will need to use the above certified systems.How is Stratech system different from the other players?

With reference to Table 1 above, Stratech uses high resolution intelligent vision whereas the other three
systems use radar. There is a likelihood that the use of radar technology may interfere with the performance of other equipment in the airport. Although Stratech’s systems incur higher up front costs, they typically require less maintenance due to its reliability, resulting in lower life cycle costs.

It is noteworthy that the iFerret contract awarded by the Dubai Airport in Jan 2014 was significant on two fronts. Firstly, according to figures from Airports Council International, Dubai Airport was the busiest airport for international travel in 2014. Thus, a contract win from such an established airport bore testament to the superiority of the iFerret system. Secondly, it was significant because Stratech has beaten the Xsight FODetect and replaced the incumbent QinetiQ Tarsier.

Intellectual property valued at S$249m – S$810m vs current market capitalisation of S$51.7m

Stratech has spent more than 25 years in investing and creatingintellectual property (“IP”). According to an independent valuation report conducted by Stone Forest Corporate Advisory, Stratech IP may be worth between S$249m to S$810m. It is noteworthy that notwithstanding the recent spike in the share price, Stratech’s current market capitalization as of 15 May 2015 is S$51.7

Inroads to military airport & airfield surveillance

In Sep 2013, Stratech announced that its iFerret has been selected by one of the top air forces. iFerret is equipped with the RADAS (Rapid Airfield Damage Assessment System) capability which can rapidly detect, locate, categorise and measure the severity of damages and hazards on the runways and taxiways. In peacetime, iFerret can be deployed for FOD Detection.

Stratech also won a contract from our Singapore government to upgrade the iFerret infrastructure to include airfield surveillance. This is noteworthy on two fronts. Firstly it marks the entrance of iFerret into Airfield Surveillance. Secondly, the FOD market / size of FOD contract could increase by at least 50% if other airfield surveillance capabilities are included.

Potential turnaround play

Stratech posted a net profit of S$1.4m for FY14 (financial year end in Mar), compared with a net loss of S$9.4m for FY13. For the 9MFY15, Stratech registered S$10.5m revenue and –S$1.7m loss. There is still a likelihood that Stratech may narrow its losses or become profitable in 4QFY15F.

According to management, Stratech is bidding for several airport contracts and they believe FY16F should be a good year, should they secure the tenders. For example, according to The Edge, Stratech is currently in negotiations to install the iFerret in six runaways at a major airport.

Risks

Adoption of FOD systems by the airports is not mandatory

The aforementioned AC guidelines are not mandatory for airports. For airports which have not decided to use the funding from AIP and PFC are not required to use the above FOD systems. Stratech is cognizant of this and it is first targeting the top airports such as the Dubai Airport in Jan 2014, Hong Kong airport in Feb 2015. Once the top airports start to adopt iFerret, the other large airports may feel “compelled” to adopt this technology. Over time, 2nd tier airports may start to adopt iFerret.

Acceptance of iFerret by airports is key

Stratech’s potential turnaround investment thesis revolves mainly around the success and acceptance of its iFerret by the airports. In the event that it did not win any of the contract tenders which they are bidding for, it may have an adverse impact on their results.

Inclusion in the watchlist is a concern

Personally, the largest risk to this company is that it has been on the Singapore Exchange watch-list since 5 June 2013, after recording 3 consecutive years of net losses. Based on my simplistic understanding, Stratech has to be profitable before tax and maintains an average market capitalisation in excess of S$40 million for the past 120 days.

Stratech has posted a pre-tax profit in FY2014, and its market capitalisation is above S$40m since 4 May. Based on my pure simple guess, there is a chance that SGX may grant an extension to them pending their discussions with SGX.

In the event that Stratech could not be removed from the watchlist or unable to get an extension from SGX, it may be delisted. Thus, this is an important point which readers should be aware.

The above are just some of the risks which readers should take note. Please refer to the Philip Securities unrated reports dated 12 Nov 2014 and 6 May 2015 for more information. 

Valuation 

According to a Philip Securities research report dated 6 May 2015, they estimate that Stratech may be able to trade between S$0.040 (steady state) to S$0.069 (high growth stage).Chart

Since 10 Apr 2015, Stratech has appreciated around 100% from $0.016 to $0.032 today. Its recent share price performance has been spectacular. However, if we pull back the chart to a ten year period, Stratech 10 year high and low price (after accounting for corporate actions) were approximately S$0.110 and $0.010 respectively.

With reference to Chart 1 below, Stratech seems to be consolidating between S$0.030 – 0.039 after its hefty gains. Measured eventual technical target for an upside / downside break points to S$0.048 / 0.021.

Supports and resistances are at $0.030 / $0.025 and $0.034 – 0.035 / $0.039 – 0.040 respectively.

Chart 1: Stratech has appreciated recently as it garners more investors’ attention

Source: Shareinvestor 15 May 2015

Conclusion

This is just a brief introduction on Stratech. Readers should be cognizant of Stratech’s watchlist status, volatile share price, dependence on the acceptance of its iFerret. However, the recent significant contract wins, coupled with the positive industry outlook should make it an interesting stock to keep it on the watchlist.

P.S. Readers should refer to the company website http://www.thestratechgroup.com/ for more information and can email me at crclk@yahoo.com.sg for the informative unrated Philip Securities research reports.

Disclaimer