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Australian shipbuilder sails into recovery with military orders

Austal sets new course by focusing on operations in US and Philippines

The second Pacific patrol boat shapes up in Henderson, WA.

CEBU, Philippines -- It starts with a giant cutout. A computer-guided router moves over a large sheet of aluminum laid flat on a table, cutting out as many shapes as possible without wastage. Then Roland Cmusos and fellow workers pick up the pieces with a gantry-mounted crane and shift them to a pallet to be wheeled away.

"It's a bit like a giant Ikea flat-pack," says Wayne Murray, their boss.

In another big shed, the pieces are being put together with flaring welding torches. The end result: a huge catamaran in gleaming metal, with workers busy fitting internal wiring and preparing to insert Rolls-Royce gas turbine engines and water-jet propulsion units. Alongside, a sister vessel is rising from the floor, weld by weld.

When completed, later this year, the two 50-meter vessels being built for Taiwan's Brave Line will take up to 550 passengers at speeds up to 40 knots (74 km per hour) from Kaohsiung in southern Taiwan to the Penghu Islands in the Taiwan Strait.

Brave Line's order, valued at $32 million with an option for a third vessel, is part of a bulging order book for high-speed aluminum ferries that has got Australian-based shipbuilder Austal doubling capacity and its 500-strong workforce at this shipyard in the central Philippines.

On the other side of the world, in Mobile, Alabama, Austal's 4,000 American workers are completing the eighth of 15 near frigate-sized ships for the U.S. Navy. Known as the Independence-class of littoral combat ships, these needle-nosed trimarans are armed with rapid-fire guns, helicopters and missiles, and can race at over 40 knots across inshore waters that are too shallow for similar-sized conventional ships. U.S. reports say each costs around $430 million, with Austal recently reporting a 7.6% margin on each contributing to net profit.

Last year, the Pentagon awarded Austal one of five commissions, each worth $15 million, given to U.S.-based shipbuilders to develop designs for a new frigate.

Austal, which says it is the world's largest manufacturer of aluminum ships, suffered a major setback in the fiscal year ended June 2016, when it was forced to write down profits on its U.S. warship operations by 156 million Australian dollars ($113.5 million), leading to a pretax loss of AU$126.4 million for the year on revenue of AU$1.339 billion.

However, the company has since bounced back strongly, with a pretax profit of AU$39.9 million in the year ended June 2017, and a 68% increase in pretax profit to AU$25.3 million for the six months ended December 2017, compared with the same period a year earlier, on revenue up of AU$653 million, up from AU$649.3 million.

The company's shares, quoted on the Australian Securities Exchange, collapsed in the wake of the U.S. write down, falling from AU$2.43 on Nov. 20, 2015 to a low of AU$1.03 on Jan. 15, 2016, but have since recovered significantly. The shares closed at AU$1.78 on Aug. 14.

But amid this success, a question is forming. Can Austal keep building ships in its home base at Henderson, just south of Perth, in Western Australia? Until recently, analysts saw Australian naval contracts with guaranteed profit margins underwriting its home operations through to 2030. But that view is changing.

"The big question mark is over their Aussie business, which continues to lose money," said Aiden Bradley, of Perth brokerage Hartleys, "and whether Austal is an Australian company in five years' time."

To its disappointment, Austal ended up with only crumbs from an AU$90 billion Australian government warship program announced in 2016. Contracts for a new generation of submarines and frigates went to Naval Group of France, and the surface ships order was awarded to British Aerospace of the U.K.

An AU$3.6 billion contract for 10 offshore patrol vessels was expected to go to Austal's Henderson yard, but the order was won by Germany's Luerssen, in partnership with Civmec, a listed engineering group based in Perth, which has no shipyard. Civmec plans to set up its own shipyard at Henderson to build the Luerssen vessels.

Austal ended up with an AU$335 million order for 21 smaller patrol boats that are to be donated by Australia to Pacific island states. In July, Canberra helped Austal by underwriting a new AU$100 million order for two 58-meter aluminum patrol boats from Trinidad and Tobago. Even so, Austal said it can sustain its current Henderson workforce only until 2021.

For the time being, the yard is busy. In a huge shed facing the winter-blue waters of Cockburn Sound, orange-clad welders are high up on gantries completing a 109-meter catamaran ferry for Denmark's Molslinjen, capable of carrying 1,006 passengers and 425 cars. The first Pacific patrol vessel, destined for Papua New Guinea, is tied up at a jetty. In a new production line nearby, the next three ships are forming under the watchful eye of naval architect Matt Kingsberg.

It is a long way from the company's beginnings under founder and current chairman John Rothwell, who arrived in Australia at the age of 10 with his immigrant parents from the Netherlands. Rothwell, who left school at 15, started out making aluminum dinghies, known as "tinnies," for lobster fishermen.

Rothwell sold that business in 1984 and bet the proceeds on potential Chinese interest in fast aluminum ferries, persuading Standard Chartered Bank to stand guarantor for two ferries worth AU$8 million. He listed Austal on Australia's stock exchange in 1998, and retains a 9.4% stake. The local arm of South African-based investment house Allan Gray is the biggest shareholder with 18.5%.

The American business is the tail that wags the dog, contributing AU$1.172 billion of the A$1.3 billion in revenues reported for the year ended June 2017. But the Philippine operation is also increasingly important. It developed from Austal's recruitment of engineers and tradesmen from the Philippines a decade ago when its own skilled workers were being lured away by high salaries offered by natural gas and iron ore projects in Australia's northwest.

With a large new assembly shed due to be finished around the end of the year, the Cebu yard will be able to build the biggest vessels in the company's catalog, including two 117-meter trimaran ferries ordered last year for 126 million euros ($143.6 million) by Fred Olsen Lines of Norway, to serve Spain's Canary Islands. A newly opened boatyard at Vung Tau in Vietnam will also be able to make small vessels or modules for the larger ones built at Cebu.

Murray, the Cebu yard's chief executive, sings the praises of his workforce. "One of the biggest attractions is that all of our workforce can speak English, so communication is immediate," he said. "You can offer praise, you can question them, and you can stop them from doing something straightaway without requiring a translator. You find Filipinos all around the world, so they're very flexible, very accommodating, and pleasant people to deal with."

The choice of location in part reflects tax breaks offered in a special economic zone at Balamban on the western side of Cebu island, where Japanese and Korean shipyards are also located, and also the availability of locally based workers keen to stay near home. Cebu City, the largest center on the island, is a two-hour drive away, across a twisting mountain road -- too far to commute. Currently, the Austal yard is training its third batch of new local hires as welders and its second batch of electricians.

With quality maintained at the same standards as Henderson -- a recent delivery from Cebu was a luxurious 56-meter ferry with reclining seats and large picture windows for Germany's Fourde Reederei Seetouristik, for runs to the Heligoland islands in the North Sea -- Austal is able to reap the advantage of the country's low labor costs.

The only other significant competitor for large aluminum catamaran ferries is another Australian shipbuilder -- privately owned Incat, in Hobart, Tasmania. It, too, is reporting a boom in orders, and this year is expanding its workforce from 500 to 750. Incat also builds versions for U.S. forces, in a joint venture with Bollinger Shipyards of Louisiana.

Austal's Cebu yard is now getting into the military side of the business. As the Philippine Navy, long accustomed to hand-me-down ships from friendly powers, is now looking at new ships after President Rodrigo Duterte budgeted 77 billion pesos ($1.44 billion) over the next five years for new equipment.

On Aug. 9, Philippine Defense Secretary Delfin Lorenzana said Austal Philippines would build six new offshore patrol vessels for the Philippine Navy. Each of the 80-meter steel-hulled ships are capable of carrying a helicopter.

Scaled up from the 58-meter aluminum vessels just sold to Trinidad, they will be designed by Austal's naval architects in Cebu and Henderson but entirely built in the Philippines, Austal Chief Executive David Singleton said. "Our Balamban shipyard will not only be able to build the new vessels but also support any through-life maintenance that is required," he said. Contract details are being worked out.

Austal is also promoting Asian sales of another ship it builds for the U.S. Navy, a 103-meter catamaran for the Spearhead-class of "expeditionary fast transports," which can deliver 300 troops and vehicles, or a field hospital, at 43 knots.

Austal's chief defense salesman, retired Australian Navy Rear Adm. Davyd Thomas, has been lauding these vessels to Japan, the Philippines and other potential customers, pointing out that the U.S. Navy used two of them in the first rush of aid to Japan's tsunami-hit region in 2011.

"I believe there is a need for those sorts of vessels around the Asian region," Thomas said in an interview at Henderson. "They are an exercise of sovereignty. They can take troops and transports to disputed islands, or islands that you wish to have a presence on. ... This is our niche, this is what we do: high-speed, rapid deployment, troops and equipment and the like."

Murray said Austal Philippines is also ready to build and deliver a littoral combat ship if Washington authorized the technology transfer. "We have the capability, undoubtedly," he said.

Filipino naval visitors are sick of having to operate a diverse fleet of used ships from other navies and coastguards, Murray said. "They really don't like that they've got this secondhand stuff," he said. "When they come down here and look around our design facilities, they walk out with chin higher, knowing they have this in-country capability."

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