Surface Transforms: Major contract win

Surface Transforms plc (LON:SCE) has announced a £20m contract with a well-known US automaker to fit carbon ceramic discs to an upgraded model of a leading sports car. Revenue will flow from 2024 and hence is not included in our estimates at this time. Initial capacity, capex, and costs for the fulfilment of this contract are already built into our estimates. This new customer (OEM 10) is the second high profile US automaker to adopt Surface’s superior technology (following OEM 8; contract value £27.5m). Generally, the Group has now secured more than £60m of OEM contracts and is on the cusp of becoming a volume supplier of brake discs. The Group may make further new contract announcements soon. Separately, we recently visited Surface’s factory near Liverpool to discuss progress with management. The plant is now much more developed with significant production equipment installed. Hiring is continuing apace with 20% more headcount targeted by the year-end. Of course, Surface is a smaller supplier to OEMs and there is always a risk of delay in drawdown of discs by its customers. That said, this new contract and customer provides significant validation of the Group’s technology and products. Our valuation is 80p, or c.30% upside to the current share price.

Major contract with new US customer – Surface Transforms has been selected as a Tier One supplier of its carbon ceramic brake disc to a well-known major US automotive company, which is now called OEM 10. The lifetime revenue on this contract is estimated to be c.£20m, commencing in mid-2024. Annual revenue is estimated to be c.£5m per year from 2025e to 2027e, with half that sum in 2024e and 2028e. All testing has been completed, and terms and conditions agreed. The contract is priced in GBP, offsetting any potential impact from currency volatility. The Group’s brake disc will be fitted as standard on both axles of an upgrade of an existing internal combustion engine model. Notably, this sports car already uses carbon ceramic discs and therefore the Group’s brake disc is replacing that of an existing and rival supplier. Talking with management, the initial capacity, operating expense, capex and working capital required for fulfilment of the contract are already built into our estimates. Clearly, revenue will come later and beyond our explicit forecasting period (i.e., 2021e-2023e) but this contract represents a c.£50% uplift in the order book for the medium-term.

Recent site visit and trading issues in H2 – Surface’s factory is based in Knowsley in the Liverpool City Region. The plant is significantly more developed than two years ago with preparations well underway to install OEM Production Cell 2 and fulfil new customer orders. The workforce will grow by a further 20% by year-end to meet expanding demand. On H2 trading (as previously discussed by the Group) Aston Martin and OEM 8 have now started to produce the vehicles that Surface Transforms is contracted to supply discs for. Deliveries for the Aston Martin Valkyrie are being made. OEM 8 deliveries are scheduled to start in Q4; design & development payments have already been received. Of course, the Group is a smaller supplier to large OEMs, and for multi-year contracts. There is always risk of delay both in developing production capacity, and with drawdown of discs by OEMs. The outturn for 2021e is particularly dependent on OEM 8 orders arriving on time. That said, good progress is being made, and this new contract award with OEM 10 is significant validation of the Group’s technology, products, and value proposition.

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