Babcock reports strong growth

Babcock International has continued with its strong growth through 2012/13, it has revealed in a pre-close trading update.

The services company said full-year numbers would be in line with previous expectations and should show progress on the previous year.

Across the business, market conditions have been positive. In both civil and military markets, a number of significant transformation and investment programmes were progressing, the company assured investors. As a result, bidding activity remained high throughout the year.

The order book remained stable at £12 billion. Since its half-year results in November 2012, Babcock has won or was preferred bidder on contracts valued at over £1 billion. Contracts at preferred bidder stage will transfer into the order book as final contract signature is completed over the next few months.

Contracts for ground fleet maintenance for British Airways and baggage-handling systems operations and maintenance for Heathrow Airport are expected to complete in the short term. Both contracts are for five years, with a two-year option to extend the baggage-handling contract, with a combined total value of £440 million.

The company is also the preferred bidder for the design, supply and delivery of two boat sets of weapon-handling and launch equipment for an unnamed international customer, expected to be worth in the order of £100 million.

Discussions with the Ministry of Defence relating to the Maritime Support Delivery Framework contract were continuing positively, the outsourcing firm said. As the new arrangements are expected to become operational later in the financial year, the existing warship modernisation initiative contracts at Devonport and Clyde have been extended for a further year from 1 April. This will increase the order book by £100 million.

The bid pipeline has increased to £15.5 billion from £14 billion in January 2013. The most significant addition to the pipeline is the logistics and commodities services transformation contract, being bid for by the defence and security division in a joint venture with DHL.

As anticipated, net debt will be approaching 1.5 times EBITDA at the year end, as the company looks to bring its net debt down.

Interactive Investor view

Babcock is the UK's leading engineer for support services and has been going from strength to strength as government cuts push departments to make cost savings and outsource services.

The group's management continues to remain upbeat about the future, with the bid pipeline showing no signs of heading south. One of the most important points is the profit margin, which is 12% before interest and tax. Thanks to this, Babcock enjoys generous free cash flow that gives the company plenty of funds to reinvest, save or return to shareholders.

Babcock's dividend income of 2.3% yield is the same as the sector average. However, Babcock has a three-year compounded dividend growth rate of 29%, implying the yield could soon overtake that of its peers.

Analyst view

Analysts at Panmure Gordon commented: "We maintain our forecasts but raise our target price to 1,050p (from 970p) to reflect the recent re-rating of the sector. However, with the share price still trending above this and earnings per share upgrades yet to come through, we maintain a 'hold' recommendation on the shares following this update."

Investec also reiterated its 'hold' recommendation, commenting: "Babcock has demonstrated once again that it is a quality business with a sizeable order book and, encouragingly, the bid pipeline continues to grow. Some of these potential new projects will not influence earnings for some years (assuming that the group wins its fair share of these opportunities), but given the group's high technical expertise, there is a fair chance of some major successes."