Morning Notes

29/09/2015 Argonaut Morning Note

Market Update & Important Indicators

U.S. stocks fell sharply, as fresh evidence of an economic slowdown in China added to investors' fears about the outlook for global growth. Energy and raw-materials producers were among the session's biggest decliners as commodity prices fell following a report showing China's industrial profits dropped 8.8% in August from a year earlier. The Dow lost 313 points, or 1.9%, to 16,002 and the S&P500 dropped 50 points, or 2.6%, to 1,882.

In Europe, the Stoxx Europe 600 declined 2.2%, dragged down by losses in the auto and mining sectors. Shares in commodities giant Glencore PLC sank to an all-time low as the mining company continued to suffer from a slump in commodity prices and concerns over its burgeoning debt-laden balance sheet. The FTSE, DAX and CAC finished the session down 2.5%, 2.1% and 2.8% respectively.

Most Asian equity markets also fell Monday. Singapore's FTSE Straits Times Index fell 1.4%, marking bear territory (defined as a 20% fall from a recent peak). The Nikkei 225 Stock Average fell 1.3%, and while the Shanghai Composite closed up 0.3%, it hovered in negative territory in earlier trading. Stocks in Singapore, a commodities-trading hub, have come under fire as signs that China's economy is slowing more quickly than expected have sent commodities prices tumbling. Earlier Monday, China reported that industrial profits in August suffered their biggest drop since October 2011.

Most commodities tracked lower overnight. Brent and WTI crude fell 2.6% and 2.8% to $47.34/bbl and $44.43/bbl respectively and gold lost 1.2% to $1,132/oz. The iron ore price was relatively steady $56.86/t, but most base metals were lower, with copper, nickel and zinc falling 1.2%, 0.7% and 0.2% respectively.

Thought for the Day

Unmanned aircraft – taking off
The growth outlook for unmanned aircraft systems (UAS) is highly appealing, with an increasingly wide range of Commercial and Civil applications. In mining and oil & gas, drones can be used for asset inspection, disaster management, surveying, mapping and imaging. In agriculture uses include crop or livestock surveillance and monitoring. Drones can be used for security, environmental monitoring, weather analysis, for news feeds, coverage of sporting events and pipeline / power line surveys. And in emergency situations (like for bushfires or law enforcement), unmanned aircraft can provide a timely and safer response.

For example earlier this month, Boeing’s subsidiary Insitu helped fight the largest wildfire in Washington State’s history as wildfires spread through 625,000 acres of America’s Pacific Northwest. Insitu’s ScanEagle delivered more than 37 hours of infrared video in real time to help fire officials pinpoint the fire’s perimeter and areas of intense heat, as well as helping helicopters with water drop locations. It is not hard to see a similar use for drones locally as Australia heads toward another bushfire season.

The Military is of course another big market for unmanned aircraft. Systems can be applied to many different payloads and to provide a range of services, like providing vital real-time information, acting as a communications relay, helping with search and rescue, and providing eyes when the action is outside line of sight. The U.S. Special Operations Command is currently tendering for Mid-Endurance Unmanned Aircraft System (MEUAS III) Intelligence, Surveillance and Reconnaissance Services. These requirements are currently being performed by Insitu and Textron, in a contract announced in late 2012 that was reportedly worth nearly US$600m.

This growing list of civil, commercial and military applications has led to big expectations for the industry. There have been a number of forecasts made, all pointing to strong growth. For example, a Market and Markets report indicates that early next decade the market for SUAS (Small Unmanned Aircraft Systems) should be well above US$1b, with the MALE (Medium Altitude Long Endurance) market worth an additional similar amount. As a subset of this, the value of propulsion systems for these two markets (~9% of the cost of the aircraft) approaches US$250m by the end of this decade according to this research.

It should be noted that predictions, particularly in the civil and commercial space, are difficult to verify or dispute, simply because of the lack of historical data. Many of the applications in this market are entirely new. Perhaps the biggest hurdle to overcome is aviation regulations in different jurisdictions, with authorities concerned about the risks to other aircraft and people, particularly where these drones are operating out of line of site. The pace of regulatory change will likely be the biggest constraint to near term civil and commercial UAS growth.

Nevertheless, we believe that it is a highly attractive sector and the opportunities considerable for those with an exposure to this industry. Orbital (ASX:OEC) is one such Company, with an excellent opportunity to commercialise its significant engine IP through its Aerospace division. OEC is a market leader for heavy fuel small unmanned aerial engine systems, and has signed a propulsion system supply agreement with the world’s largest SUAS operator, Insitu. Very positively, OEC recently announced the first order from Insitu worth US$9.7m. We expect there is a good chance that this will lead to a longer-term production contract and the establishment of facilities in the U.S. We currently have a buy recommendation on OEC and a $1.10 valuation (for the most recent research, please refer to Set up for growth, 31/08/15).

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