ii view: Babcock shares rally to multi-year high

AGM trading update

ii round-up:

Engineering and defence company Babcock International Group (LSE:BAB) today flagged an encouraging start to the financial year as it left its annual sales and profit expectations unchanged.   

Babcock, whose activities include servicing naval warships, pointed to good organic revenue growth and improved cashflows year-to-date, helped by a stronger operational performance. 

Shares in the FTSE 250 company rose more than 5% to prices not seen in over three years, having come into this latest news up by just over a third year-to-date. That’s better than a one-fifth gain for UK defence giant BAE Systems (LSE:BA.) and in contrast to a 5% retreat for the mid-cap index itself. 

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Babcock delivers critical and complex engineering services across marine, land, aviation and nuclear. As well as servicing marine warships and nuclear submarines, it also supports land and aviation fleets such as those of the British army and Canadian air ambulance service.

Operating profit year-to-date had been aided by its contract to build type 31 frigates for the Polish navy. During its last financial year, Babcock completed a push to realign its business portfolio, with over two-thirds of its revenues now defence related. 

Accompanying management outlook comments detailed hopes of further underlying profit margin expansion, and progress towards its medium-term forecasts given ongoing new programme wins, contract renewals and progress on its opportunity pipeline.

First-half results to the end of September are currently scheduled for 14 November.  

ii view:

Employing around 26,000 people, Babcock provides equipment support, training and equipment manufacturing to defence, security, and civil markets. Customers for its biggest marine division generating around a third of sales include the British, Australian, and Polish navies. Nuclear related sales including those for the UK’s submarine fleet account for a further quarter of overall sales, with Land and Aviation revenues each coming in at around a fifth. Geographically, the UK dominates at around three fifths of revenues, with other contributors including Europe at just over a tenth and North America at under 5%.   

For investors, elevated costs generally for businesses including those for energy, raw materials and wages should not be overlooked. The stretched finances of the UK government - Babcock's biggest customer - warrant consideration, with defence spending potentially easier to cut than say health or education, while changes of government also raise uncertainty given possible changes in spending priorities. 

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On the upside, Russia’s invasion of Ukraine and increased Western tensions with China have arguably underlined the importance of defence spending. Actions to strengthen Babcock’s balance sheet were previously taken via business disposals. Babcock is confident it can deliver on medium-term targets such as generating average annual revenue growth of mid-single digits, while previously outlined management plans to reinstate the dividend sees the shares sat on a forecast dividend yield of around 2%.   

For now, and while some caution looks sensible given the dramatic share price recovery, heightened global political tensions typically help the defence industry.

Positives: 

• Reduced complexity and increased focus
• Plans to restart the dividend payment

Negatives:

• Business sales have reduced its diversity of operations 
• Elevated costs

The average rating of stock market analysts:

Buy