ii view: Babcock profit sinks, but market likes the shares

It's worth 40% less in 2020 and the dividend remains suspended, but the shares are at a five-month high.

First-half results to 30 September

• Adjusted revenue down 7% to £2.24 billion
• Adjusted operating profit down 43% to £143 million
• No interim dividend payment
• Net debt down 13% to £1.52 billion  

Chief executive David Lockwood said:

"In my first three months at Babcock I have spent time seeing many parts of the business. Our strengths are clear. We have many high-quality businesses, with a deep understanding of our customers, operating in markets where demand for our expertise is strong. At the same time, there are areas that need to be addressed if we are to achieve our full potential. The most important aspect will be delivering sustainable free cash flow.

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"In the coming months, we will be reviewing our strategic priorities, execution and delivery. I look forward to reporting back on this in May. In the meantime, we remain focused on delivering for our customers, employees and shareholders and continue to look to the future with confidence."

ii round-up:

Engineering and defence company Babcock International (LSE:BAB) reported a near halving in profits as both increased Covid related costs and operational inefficiencies impacted.  

Half-year operating profit fell by 43% to £143 million, marginally missing City forecasts of around £146 million, with a decision taken to again not pay a dividend given the ongoing uncertainty of the pandemic. 

Babcock shares were little changed in afternoon trading, although still down over 40% for the year-to-date. Shares of BAE Systems (LSE:BA.) are down by less than 10% in 2020 while shares of QinetiQ Group (LSE:QQ.) are down around 15%.

The government’s insourcing of both the Magnox and Dounreay nuclear projects, and weak trading in civil aviation, also feed into the weak profit mix. Its aviation business includes the now thrifty oil and gas industry which has been busy reducing services to offshore facilities.  

The critical and complex engineering services provider delivers it services across the four arenas of marine, land, aviation and nuclear. Along with servicing marine warships and nuclear submarines, it also supports land vehicle fleets such as those of the British army and Met police.  

Covid challenges and inefficiencies have been given the often-close working proximity of its staff on ships and submarines for example. More favourably, revenues for its marine business were aided by a ramping up of the navy’s Type 31 programme, while an extension of its Met Police vehicle contract and new civil aviation contracts were won. 

ii view:

Employing over 35,000 people, Babcock’s primary market remains UK defence. Both UK and overseas government spending has now rocketed under the cost of the Covid-19 crisis. Significantly elevated government borrowing levels remain set against geopolitical tensions, the rise of China, and a Russia still struggling with the break-up of the former Soviet Union. 

For investors, an order book of £17 billion provides some reassurance, while a previously rejected merger proposal from Serco (LSE:SRP) suggests potential for M&A activity. But the ongoing suspension of the dividend payment, a continued lack of group financial guidance looking ahead, and the now precarious state of government finances, both in the UK and overseas, all offer reasons for caution. For now, and despite no current UK targeting of defence spending cuts and even an increase to boost jobs, investors may wish to take a ‘wait and see’ approach given the degree of outlook uncertainty. 

Positives: 

• Order book of £17.2 billion
• Previous merger/takeover proposal from Serco – rejected by Babcock

Negatives:

• High Covid operational challenges
• Dividend payment suspended

The average rating of stock market analysts:

Strong hold