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13 January 2005
OPEN BRIEFING
CEO on Outlook
corporatefile.com.au
Orbital Corporation Limited recently lodged
its 20-F Annual Report with the US SEC, providing the market with
more detail on the performance of Synerject, your 50:50 joint venture
with Siemens-VDO Automotive. In the year ended June 2004, Synerject
increased its profit to US$3.4 million from US$1.1 in the previous
year. What were the drivers of this improvement?
CEO Peter Cook
The profit improvement came from a 3 percent
rise in sales to US$40.0 million and an increase in EBIT margin
to 10.6 percent from 5.3 percent. The improved margin was a function
of the synergies that have been delivered following the restructure
announced in the last quarter of the 2003 fiscal year.
corporatefile.com.au
Synerject generated US$4.5 million cash in
2004, of which US$3.8 million was used to repay debt. What are Synerject's
cash generating potential and cash requirements during the current
year ending June 2005?
CEO Peter Cook
We expect Synerject to continue to improve
its cash generation this fiscal year even after a reasonable increase
in R&D expenditure. Synerject's debt repayment obligations in
2005 are very similar to 2004, so surplus cash will be used to service
the small increase in working capital requirements needed for growth.
We've agreed with Siemens-VDO that cash generated by the joint venture
will primarily be allocated to debt reduction in the period up to
September 2006, at which time the debt financing will be reviewed.
corporatefile.com.au
Assuming Synerject's loan from the joint venture
partners hasn't been fully repaid by the time of that review, what
are your plans for refinancing?
CEO Peter Cook
Forecasting two or three years out is always
risky but at the time of the last refinancing, which was about 18
months ago, we expected Synerject's net debt to be reduced to well
below US$10 million by September 2006. In addition, we expected
its balance sheet to strengthen and indeed we've seen the start
of that with shareholders' funds improving to positive US$1.1 million
at June 2004 from negative US$2.6 million a year earlier. We expect
that improvement to continue.
Clearly, a number of options are viable. For
example, Synerject in its own right would have more than enough
financial strength to establish a loan from any of the mainstream
banks to cover its debt needs. Alternatively, the current loan could
be extended, which hasn't been ruled out, or further liquidity could
be provided through equity by either or both of the joint venture
partners.
It's too early for us to be too dogmatic about
which of these options we'll prefer, but we're very pleased with
Synerject's progress to date, including its performance for the
first six months of this fiscal year.
corporatefile.com.au
In 2004, Synerject made a A$2.7 million contribution
to Orbital's earnings, up from A$1.4 million in the previous year,
and you've said 2005 would be a "year of consolidation"
for the joint venture. What's the earnings outlook for the full
year and the future?
CEO Peter Cook
To date Synerject's tracking to plan and we
have no reason to doubt its ability to deliver for the full fiscal
year. We've used the phrase "year of consolidation" to
describe a year without major restructuring activities, in which
Synerject focuses on the business basics. That includes laying the
basis for product successions in future years through an increase
in R&D effort and also laying the basis for growth in the markets
of Asia, including India and China, and establishing how Synerject
can best service these markets.
In addition to the contribution Synerject makes
to our earnings, it's important to recognise the value for us in
the Synerject asset. Synerject's now a US$40.0 million business
generating cash and solid profits from its global customers in the
US, Europe and Asia.
corporatefile.com.au
In 2004, Synerject's sales were affected by
the financial difficulties of one of its major customers, Aprilia,
which itself has recently been taken over by Piaggio, also a Synerject
customer. What's the expected impact of the takeover on Synerject's
sales into the European scooter market?
CEO Peter Cook
We've seen consolidation very frequently over
the years in the automotive sector and less frequently in the non-automotive
sector. Mergers and acquisitions are a fact of life in our industry
and have to be managed. The biggest risk with Aprilia was prior
to its sale, when cash problems meant there was a risk of bad debt.
Fortunately that's been averted and negated with Piaggio's acquisition
of Aprilia.
To date, we've not seen any extensive rationalisation
of models across the Aprilia and Piaggio product ranges and we understand
that Piaggio will continue to promote both brands while taking advantage
of shared development costs and manufacturing synergies. This is
a more than satisfactory outcome for Synerject, with the acquisition
having a small positive impact on its business in the European scooter
market.
However, I should add that the European scooter
market itself is continuing to change and is being influenced by
the threat of legislative change on many fronts, from the licensing
age for riders, to a possible reduction in the licensing age for
a car driver, to the use of safety helmets, as well as the tightening
of emissions standards. These factors are likely to be much more
significant to the market's overall size and dynamic than Aprilia's
acquisition by Piaggio.
corporatefile.com.au
What will be the longer-term drivers of Synerject's
growth?
CEO Peter Cook
Synerject's main market is the conversion of
non-automotive engines to EMS. Because of cost considerations, motorbike
engines have been slower than cars to adopt EMS. However, with low
cost volume production of EMS now available, the market is growing
quickly. The products and disciplines needed for non-automotive
applications are different from those needed for the automotive
sector, so Synerject is well placed to exploit that growth over
the next few years. Because much of the growth will be in Asian
manufactured products, particularly from India and China, it's important
that Synerject build on the position it's already established in
India through its UCAL licence arrangements to more fully exploit
the market.
corporatefile.com.au
You recently confirmed the release of five
new products utilising Orbital Combustion Process (OCP) technology,
including the Suzuki Katana 50cc direct injection scooter in Europe
and Taiwanese manufacturer Kymco's first OCP model, a 100cc scooter.
What's the expected impact of these new model launches on Orbital's
royalty and other income over the remainder of the current financial
year and going forward?
CEO Peter Cook
The Suzuki Katana and the Kymco models are
new additions to the field but we shouldn't lose sight of the fact
that existing licensees continue to launch new models or upgrade
existing models on a regular basis. All new models improve our overall
performance, particularly over the medium to long term, and shareholders
should be encouraged by the activity of our licensed OEMs in the
sector.
However, our most significant licensee is Mercury
Marine, and the extension of Optimax, using OCP technology, onto
its I-3 range 12 months ago remains noteworthy. Whilst it's early
in the launch cycle and there have been some major changes in the
US outboard engine market, particularly anti-dumping action by Mercury
against the Japanese 4-stroke makers, the development is still significant
for us. Similarly, the move by Bajaj, the Indian 2- and 3-wheel
vehicle maker, to adopt OCP on a number of its auto-rickshaw models
for launch in December 2005, is likely to be of much greater significance
to our financial performance than the individual models identified
above.
corporatefile.com.au
A key strategic focus for Orbital is R&D
targeted at the development of second-generation OCP products. To
what extent is this R&D necessitated by the emergence of competing
technology and what's the anticipated cost of developing second-generation
products?
CEO Peter Cook
Second-generation OCP products are based on
design improvements we've identified with the help of our OEM customers
to meet specific market needs including price, focused functionality,
ease of use and application. There are no truly direct competitive
technologies driving this development. However, an improved cost
position for example would make the conversion of carburetted engines
easier or less expensive for the OEM. Because this is a focused
development program, the costs are not high for us. We don't expect
the cost of the whole program to exceed A$250,000.
corporatefile.com.au
You've also identified the use of OCP to develop
engines capable of running on multiple fuels as an opportunity for
Orbital. Would the use of this type of engine be confined to the
marine sector? What's the potential market?
CEO Peter Cook
The initial interest in dual-fuel capability
has been in relation to outboard marine engines, and the commercially
available engines are in that sector. But we don't see applications
necessarily remaining restricted to the sector. There's adequate
evidence that some All Terrain Vehicles, some motorcycle applications
and some quite specific aeronautical engines could be potential
candidates for dual fuels. At this stage a market doesn't exist
in a conventional sense but there's the potential for it to develop
given the ever widening range of fuels being considered for use
in engines. For example, while alcohol or gasoline-alcohol mixtures
may be of interest in a particular geographic area, an OEM could
not expect to recoup the cost of developing an engine for such a
localised need. Dual or multiple fuel use however, may prove to
be a cost effective solution.
The need for interchangeability between diesel
and compressed natural gas (CNG) or natural gas itself on stationary
power generation equipment and to a lesser extent on public transport
buses is recognised, but most of the solutions proposed to date
carry serious limitations.
corporatefile.com.au
What's driving the current interest in alternative
fuels, including CNG, hydrogen, bio-diesels, alcohol and gasoline/alcohol
blends?
CEO Peter Cook
Generally all fuels that are renewable or contribute
less to greenhouse gas formation will continue to be of interest.
CNG for example is frequently a by-product of oil extraction or
refining and is greenhouse positive if it can be used for transport
or energy production rather than simply burnt off. However, getting
longevity from engines running on CNG is another matter. Hydrogen
presents different problems, for example its storage and transport,
not to mention its generation and availability. These aren't areas
of direct interest to power-train engineers, but difficulties with
containment of hydrogen at the injector when it's used as a combustible
fuel are, and this is an area where Orbital has considerable expertise.
Before alternate fuels can be used in practice, these problems need
to be addressed and overcome.
The need to address these and other related
issues is creating opportunities for our unique skills and understanding
in power-train combustion and we expect to be involved in a number
of fee-earning, client projects over the coming years. This doesn't
mean there'll be an overnight revolution away from improving the
efficiency of conventional petrol and diesel engines, but many alternatives
will continue to be explored and the best of them adopted.
corporatefile.com.au
Thank you Peter.
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