Babcock shares surge after declaring ‘new era for defence’

With increasing military tensions firmly on the global agenda, Babcock International Group (LSE:BAB) has caught the zeitgeist in delivering a sparkling set of numbers.

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Revenues of £4.83 billion for the year ended 31 March was up 10% compared to the previous year, with profitability spiking sharply by any measure. Operating profit of £363.9 million was 51% higher than the corresponding period, while pre-tax profit rose by 52% to £329.1 million. 

The improvement in key metrics does not stop there, however. Underlying operating margin increased from 5.4% to 7.5%, prompting the company to upgrade its medium-term guidance to at least 9% from the previously estimated 8%, in addition to a revenue outlook which was revised higher to come in at mid-single digit growth. The strong cash generation also enabled net debt to be reduced to £373.3 million from a previous £435.4 million, itself an improvement of 14% in just one year.

This strengthening financial performance also resulted in an increase to shareholder returns. While the dividend increase to a projected yield of 0.6% is marginal, the announcement of a £200 million share buyback programme for the first time in the company’s history s a clear statement of intent and confidence in future prospects.

Indeed, the backdrop is set fair. Around 62% of group revenue is derived from UK defence, where the latest government announcement has pledged to spend 5% of GDP by 2035, leaving the door ajar for Babcock to make further progress.

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Of particular interest is the likely concentration of spend on the civil and defence nuclear budget. Nuclear accounts for 37% of group revenues and is Babcock’s largest unit, with its expertise in submarines also reaching over to its Marine business, which is the second largest revenue driver responsible for a third of sales.

The more immediate outlook also seems assured. The contract backlog now stands at £10.4 billion, the group is in collaboration with any number of overseas companies which extends its reach, while Babcock is also looking closely at bolt-on acquisitions. In the 12-month period, two were considered but judged not to meet the group’s financial hurdles for adequate value creation. Even in the absence of acquisitions, the cash generation has enabled ongoing investment in the business, where rapidly evolving technology remains a key factor.

The sector is one which has lifted most boats in light of recent developments and Babcock is no exception. If there is a question mark over its current status, it is one of valuation rather than any lessening of opportunities emerging in the short and medium term. Given the group’s stellar share price appreciation, the historic valuation is beginning to look punchy and as such the bar will be set increasingly high for future updates.

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The company may have joined the FTSE 100 in March by default following the delisting of another constituent, but it is now clearly established. The shares have risen by 257% over the last two years, by 88% over the last year which compares with a gain of 6.3% for the wider FTSE 100 and by 106% this calendar year alone.

By any standards, this raises questions, but an increasing commitment to defence spending, allied to a possible rerating of the sector, adds an intriguing set of prospects to the mix. The initial share price reaction to the numbers reflects a further standing ovation, and the market consensus of the shares as a strong buy should therefore remain firmly intact.