Why Some ASX Defence Stocks Are Surging While Others Keep Falling

Austal is in talks to sell its US business while Electro Optic Systems is struggling after a big contract win. Here’s how ASX defence stocks are moving

Defence stocks on the ASX are having a mixed day. Austal (ASX: ASB) shares jumped more than 10% on 14 October after the shipbuilder announced the start of commercial negotiations with Hanwha regarding the possible sale of US operations. At the same time, the aviation and defence group suffered a major setback, with Electro Optic Systems (ASX: EOS) feeling the brunt of it.

The disparity in performance highlights the fact that contract wins, corporate activity, and profit-taking are all playing out differently in the sector, even while defence spending continues to rise across the globe.

Austal rises on US business talks

Austal made an announcement confirming that it had prolonged the period of due diligence for Hanwha Defence USA and that the negotiations on the potential transaction were being held. Prior to this, the company had indicated that it had received non-binding interest for its American shipyard operations, which were estimated to fall between US1.05 billion and US1.2 billion.

Austal’s operations in Australia have been successful in the recent past, while the company’s businesses in America have struggled because of margin pressures and issues with contracts. A potential sale would streamline the operations of the entire company and bring value to its American assets. The shares of the company reacted positively to this news, closing up for the day.

Austal remains well-connected to Australia’s naval shipbuilding through its contract based on the Strategic Shipbuilding Agreement and the production of Landing Craft Heavy vehicles.

Electro Optic Systems: big contract, volatile reaction

Electro Optic Systems declared a highly anticipated nationwide counter-drone defence contract worth roughly A$700 million (about £370 million) with a nation in the Middle Eastern Gulf. The firm termed the contract its largest to date as it entails creation and installation of an integrated system based on the NiDAR command-and-control tool.

At first, the company's shares grew sharply to hit all-time high of around A$12.91 before a quick turn. In the first days to follow, the stock witnessed a drop pushing the aerospace and defence sector to wipe about 19 per cent off its market value within the week. The company mentioned that the contract had a number of risks, which it planned to mitigate, as some of the contract requirements had not been met yet.

EOS managed to expand its operations in the anti-drone and remote weaponry sector after completing some previous orders and making MARSS acquisition. Despite the last deal boosting the amount of orders substantially, the market seems to consider factors like successful implementation, timing, and the gap between notice and actual revenue realization far more important.

DroneShield and the broader sector backdrop

DroneShield (ASX: DRO) is another counter-drone company that has seen a large decline from earlier peaks. Despite being previously strong over multiple years due to sales growth and interest in counter-drone systems, the stock has had its issues in the face of new revenue announcements failing to sufficiently compensate for an earlier valuation correction.

For the wider ASX Aerospace & Defense group, the last few weeks have been quite tough with an approximate 15% drop over seven days and a considerable decline over the last year cumulatively. It should be noted, however, that changes in stocks of individual companies rather than overall changes in perception of the group seem to be driving the day-to-day fluctuations.

What is driving the split

There are three key considerations.

Firstly, commercial activities can be more prominent than the ramifications of operations. Austal’s discussions about its US operations demonstrated that value generation was plausible and the investment case simplified for certain investors.

Secondly, significant contract signings hold the potential to stir up both enthusiasm and wariness. EOS’s $700 million contract proved that there is market demand for its products and also drew attention to logistical challenges in delivering complicated systems in other countries. Therefore, profit-taking after the advance is present in the price movement.

Finally, a lot of companies belonging to the defense technology sector have already run high on the back of heightened international turmoil and increased funding. In case of any disappointing performance or overly fresh impressions and the greater visibility of risks in execution, the quotes of shares may fall.

Political situations are usually in favor of the long-term demand for naval ships or counter-drone systems, as well as for new devices in this area. However, domestic support by the way of the domestic growth in defense expenditures and events related to AUKUS do not add to optimism concerning the short-term forecasts concerning share prices.

What comes next

The negotiations between Austal and Hanwha will be closely followed in case of a binding proposal or an update relating to timing and terms. Electro Optic Systems will be evaluated on its advancement in converting its Gulf contract and other orders into actual systems sold and earnings generated. DroneShield and its peers will continue to report on order flow, production ramp-up and success in achieving profitability.

Investors observing the industry are showing less interest in overall geopolitical stories and more on the specifics of the delivery and margin result and capital allocation decisions. The current divide between the companies whose prices have gone up and those which have gone down in price shows that even in the era of the supportive narrative some practices prevail. 

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