Global defence spending up, AL3 revenue up, US sales up.

Disclosure: S3 Consortium Pty Ltd (the Company) and Associated Entities own 6,777,530 AL3 shares at the time of publishing this article. The Company has been engaged by AL3 to share our commentary on the progress of our Investment in AL3 over time.

Is the share price about to break its 52 week high?

Just as our Investment AML3D (ASX:AL3) is about to start a big push into the US?

AL3’s push into the US is actually underway right now - US sales are already coming in.

That’s even before its Ohio manufacturing hub becomes ‘fully operational’ this quarter...

While defence spending is on the rise globally.

AL3 reported its quarterly results today.

Off the back of signing Master Licencing Agreements (MLA’s) with the US Navy and Boeing Defence and Space earlier in the quarter.

Receipts from customers are up 16.5% on this quarter last year to $2.75M.

Operating cash burn was reduced to just $0.38M, leaving it with a cash position of $6.85M - that's a long 18 quarters of runway at current burn rates.

When we consider the list of major companies queuing up to use AL3’s tech this number is impressive.

AL3 has already established itself in markets where average contract sizes could be multiples of AL3’s existing revenues.

It’s already got the following blue chips clients using its products - these types of customers aren’t easy to break into.

We think the two most important deals AL3 has signed so far are related to what's called Master Licensing Agreements.

MLAs enable the exchange of highly sensitive technical data and assistance required for 3D printing a wider “menu” of parts for certain large customers.

Each Manufacture Licence Agreement expands the product suite for AL3 and its customers.

AL3 has MLAs with:

• Boeing Defence and Space
• Blue Forge Alliance - an intermediary for the US Navy.

Next we are waiting for revenues from those MLAs to kick in.

Almost 89% of AL3’s revenues came from the US during the September quarter.

(Looks like the US expansion is working)

Our view is that once these MLA’s start kicking into gear, the orders will start to flow in pretty quickly.

That's where we expect the step change increase in revenues to come from.

Any new MLA’s on top will just be an added bonus, if AL3 can get ones signed.

AL3 is a technology company building out a product suite that combines robotics, welding, automation and software.

AL3 has developed a technology to “3D print” complex industrial parts for the defence, oil & gas and aerospace industries:

The market looks like it’s rewarding AL3’s progress this quarter - with the AL3 share price moving from 16.5 to 19.5 in just the last few weeks:

The past performance is not and should not be taken as an indication of future performance. Caution should be exercised in assessing past performance. This product, like all other financial products, is subject to market forces and unpredictable events that may adversely affect future performance.

AL3 has recently crept up to ~ 20c - can it test its 12 month high over the coming weeks?

Today we will unpack today’s AL3 quarterly and review another ASX defence tech stock that has delivered some pretty impressive returns for early investors... We are hoping AL3 can deliver something similar one day.

Since we first Invested in AL3 in the June this year, the company has:

• Announced the sale of $1.1M ARCEMY 3D printing system to a parts manufacturer supporting the US Navy. (Read more here)
• Signed a Defence Manufacturing License Agreement (“MLA”) with Boeing Defence and Space. (Read more here)
• Reported FY24 revenue of $8.5M, up 500% on last year. (Read more here)
• Singed another MLA with Blue Forge Alliance, the US Navy intermediary that supports the US Navy’s submarine parts supply chain, one of AL3’s core customers. (Read more here)

AL3 is positioning itself to become the parts supplier of choice for the US Navy, Boeing Space and Defence, and potentially a whole host of other industries and blue chip customers that need parts printed close to the point of need.

Traditional methods of making these parts are slow and inefficient because they are made off site.

Traditional turnaround times can take months and AL3’s 3D printing is better in almost every way than traditional “casting” or “forging”...

In contrast, AL3’s 3D printed parts are harder, better, faster, stronger.

AL3’s tech can make parts up to:

• 75% faster than forging or casting
• 30% stronger than a cast or forged part
• 50% more resistant to metal fatigue
• 95% less material waste costs

(Source - AL3 Presentation, March 2024)

We’ve been to Adelaide to see how this tech works for ourselves:

AL3 is pursuing an aggressive “scale up” strategy targeting the defence, aerospace, marine and oil & gas industries in the US.

All of these are industries that need highly specialised, expensive parts and equipment to operate.

AL3’s Ohio-based manufacturing hub is set to be fully operational before the end of this year, and we think this could trigger a step change improvement for revenues.

AL3’s sales funnel is as follows:

• AL3 signs a contract to custom 3D print a metal part for a customer.
• THEN, the customer tests the 3D printed part and confirms they are happy with it.
• THEN, the customer can lease or rent its own ARCEMY 3D printing system so they can print their own parts whenever they need.
• THEN, the customer can buy the ARCEMY system outright from AL3.

The manufacturing hub in Ohio AL3 will be able to better service the top-of-funnel market where the company signs contracts to 3D print a specific metal part for a customer.

This will open many more doors and opportunities for the company to showcase its product and the potential efficiency savings that these companies are looking for.

Also, being based in the US, AL3 will be eligible to bid on lucrative US Defence contracts that value discretion and national security.

AL3 already has inroads into the US Navy, however by having a US-base it strengthens the opportunities in the region.

The US is really the name of the game for AL3 with 89% of all sales in the last quarter coming from the region.

More on AL3’s quarterly results

The highlight number for AL3 is that it secured $2.75M in sales receipts from customers.

This is a 16.5% increase compared to the previous corresponding period.

AL3 had $6.85M in cash at the end of the quarter, which we think is plenty of runway to execute on its US sales and growth strategy given the company is bringing in enough revenue to offset expenses.

AL3’s go-to-market strategy is to expand its product offering and credentials through what are called Manufacture Licence Agreements (MLAs).

This enables the exchange of highly sensitive technical data and assistance required for 3D printing a wider “menu” of parts for the US Navy.

Think of it like securing a restaurant on the UberEats app... but for complicated large mechanical parts.

Each Manufacture Licence Agreement expands the product suite for AL3 and its customers.

AL3 has now signed two MLA’s:

• First with Blue Forge Alliance Group (Read more here)
• Second with Boeing (Read more here)

Now we are waiting for the first revenues to start to come in from both of those MLAs.

Other interesting updates on customer contracts include:

In particular the Century Engineering deal is interesting because it highlights AL3’s move into the Australia Defence, mining, power and water industries.

AL3 also mentioned that it is investing in R&D to improve the “deposition rates” of its ARCEMY product (which is effectively a measure of how fast the 3D printer can build the desired product).

Overall a strong quarter from AL3 with progress made on a number of individual contracts as well as the larger “Manufacturing Licencing Agreements.”

We are hoping that things continue to ramp up with Ohio Manufacturing Hub expected to be in full gear before the end of the year.

The sales cycle for these lucrative defence contracts can and do take time, however once a company is established there revenues can grow quickly.

A model for success: can AL3 “do a Droneshield”?

When we Invest, we like to look for similar companies that show what success can look like for our Investment.

And the defence thematic has delivered one of the big success stories of 2024 - Droneshield.

This year, ASX-listed Droneshield reached a valuation of $2BN.

Just 12 months ago, the company was valued at ~$350M.

The playbook has been written, let’s take a closer look...

Since November last year, the Droneshield share price has moved from 28 cents to a high of $2.60 when a short report came out on the company and spooked the market.

Today, the company is steadily trading around the ~$1 mark, and has a market cap of ~$860M.

Since the start of the year, the company has completed TWO six figure capital raises off the back of strong retail and institutional support:

The past performance is not and should not be taken as an indication of future performance. Caution should be exercised in assessing past performance. This product, like all other financial products, is subject to market forces and unpredictable events that may adversely affect future performance.

The market success of Droneshield can be traced back to a series of specific charts that the company published in its annual report:

(Source - DRO Annual Report)

In the 12 months prior, Droneshield delivered:

• 3x growth in revenue
• 4x growth in SaaS revenue
• 5x growth in Cash Receipts
• Moved to profitability

Large institutional and sophisticated tech investors want to see recurring revenue, and we saw them come for Droneshield (via those $100M and $120M cap raises) in a big way.

We want to see AL3 deliver material increases in contracts and revenue Year on Year - these are catalysts we think could trigger a re-rate in AL3’s share price.

We will be watching for more new contracts to be announced by AL3 (especially big ones) and also increases in quarterly revenue numbers to the prior corresponding quarter (like we just saw today).

The macro investment thematic winds are also blowing in AL3’s favour...

Defence stocks has been a big macro theme for 2024

With China challenging the US led world order and the world a bit on edge at the moment, we have started to see big increases in spending on defence, even by passive countries.

8 weeks ago Poland announced a “record” and “unprecedented” defence budget.

(Source)

Around the same time Japan requested its largest ever defence budget.

(Source)

Back in April, FT reported that global defence and military spending is on the rise:

(Source)

(Source)

And:

(Source)

Increased geopolitical tensions just means more spending, which may mean this is a structural change to defence spending around the world and not just a temporary move by certain countries.

In June Anduril raised US$1.5BN at a US$14BN valuation.

(Source)

Palmer Luckey is perhaps best known as the founder of Oculus Rift, which was acquired by Facebook.

He then went on to found Anduril - and it looks to be going well.

This deal underscored the interest from the Silicon Valley (and beyond) VC community in defence technology, particularly as conflicts grew in the Middle East and in Europe.

This interest trickled down into other defence companies like Droneshield.

Normally, SaaS businesses are valued at an 8-12x Annual Recurring Revenue (ARR) multiple.

But at its peak Droneshield was valued at a 40x ARR (and today still a 17x ARR) multiple.

This premium, relative to other tech companies, is reflective of the investor appetite for companies leveraged to the defence macro environment.

And we think that AL3 is in a strong position to capture this value too.

AL3 published its annual report last month and showed a 10x uplift in revenues for the financial year.

Now, the company was coming off a small base under $1M revenue.

We think the bigger institutional tech investors are probably waiting to see bigger growing revenues to really get behind AL3 (which is where we think there is upside in the company).

To that point, the $7.3M in revenue achieved in the last financial year provides a strong baseline for growth for the company.

(Source)

AL3 has a strategy for rapid growth and expansion into the US in which we think can deliver a ‘Droneshield-like’ revenue uplift - provided AL3 can execute on the strategy.

As we mentioned above, AL3’s new facility in Ohio will be in full swing before the end of the year.

The facility opens up the opportunity to fulfil “lucrative International Traffic in Arms Regulated (ITAR) Defence contracts that are limited to US based manufacturers”.

So far, the US strategy is working.

95% of AL3’s revenues came from the US market this year.

AL3 committed to the US push, and their ability to execute this push was a core component of our AL3 investment thesis.

Our “Big Bet” for AL3 hopes for a market cap of $500M on achieving significant sales growth.

At a 17x ARR (that Droneshield currently is at) would need to see AL3 reach around $30M in revenues.

We think that this is achievable over the next 2 to 3 years as the company becomes established in the US and fortifies its foothold into the US Defence Industry.

Our AL3 Big Bet

“AL3 re-rates to a $500M market cap on achieving significant sales growth across an expanding range of industries and jurisdictions”

NOTE: our “Big Bet” is what we HOPE the ultimate success scenario looks like for this particular Investment over the long term (3+ years). There is a lot of work to be done, many risks involved - just some of which we list in our AL3 Investment Memo. Success will require a significant amount of luck. There is no guarantee that our Big Bet will ever come true.

What are the risks?

In the short term, the key risks we are conscious of for AL3 are “Sales risk” and “Market risk.”

As AL3’s share price increases, the expectations for future sales/growth increase.

If AL3 fails to deliver more sales and its financial performance suffers, the market may start to price in lower growth potential for the future and re-rate AL3’s share price lower.

Sales risk

There is always the possibility that AL3 does not close more sales, and its financial performance suffers as a result.

Source: “What could go wrong” section - AL3 Investment Memo 27 June 2024

At the same time, if market sentiment were to turn negative, investors might sell down high-growth, cash-burning companies like AL3 in favour of safer, profitable companies.

AL3 is dependent on investors' willingness to back currently loss-making, but potential high growth businesses as they work towards further growth and eventual profitability.

Market risk

There is always a possibility that the broader market sells off dragging AL3 shares with it. Or alternatively there could be sector specific pain ahead for the tech industry, hurting companies like AL3.

Source: “What could go wrong” section - AL3 Investment Memo 27 June 2024

Our AL3 Investment Memo:

In our AL3 Investment Memo, you can find the following:

• What does AL3 do?
• The macro theme for AL3
• Our AL3 Big Bet
• What we want to see AL3 achieve
• Why we are Invested in AL3
• The key risks to our Investment Thesis
• Our Investment Plan