Interactive Investor

ii view: Babcock profits sustain damage

Oil & Gas industry woes follow the departure of the CEO. Should investors be jumping ship?

12th February 2020 11:11

Keith Bowman from interactive investor

Oil & Gas industry woes follow the departure of the CEO. Should investors be jumping ship?

Nine-month trading update

  • Order book at £18 billion, unchanged year-over-year
  • Pipeline up £2 billion to £16 billion

Full-year guidance:

  • Underlying revenue around £4.9 billion, unchanged on previous forecast
  • Underlying operating profit around £540 million, down from a range of £540-£560 million

ii round-up:

Critical and complex engineering services provider Babcock International (LSE:BAB) splits services into four areas: Marine, Nuclear, Land and Aviation. 

Along with servicing marine warships and nuclear submarines, it also supports land vehicle fleets such as those of the British Army and the helicopters used by oil companies to support offshore operations. 

In this latest update, challenges for its Aviation sector saw it flagging an £85 million exceptional charge. A reset in pricing by the three big providers of helicopter services to the oil and gas industry had caused it to adjust its own pricing to those providers. Restructuring and costs relating to the write down of assets and leases explain the exceptional charge.

Guidance or management estimates for full-year adjusted profit were lowered from a previous range of £540 to £560 million down to around £540 million. 

The share price fell by more than 5% in mid-morning UK market trading, compounding a halving in the share price over the last five years and contrasting starkly with a near doubling in rival QinetiQ Group's (LSE:QQ.) share price over the same period. 

Just a few days ago, Babcock announced the retirement of its chief executive Archie Bethel, with a successor yet to be found. The group, which employs over 35,000 people, is scheduled to report full-year results in late May. 

ii view:

Babcock’s primary market remains UK defence. Along with maintaining and growing its UK business, management is also focused on expanding its international operations. Marine and Land each account for around one-third of group sales, Aviation a fifth and the balance Nuclear. 

Government defence spending both in the UK and overseas remains under review. Elevated borrowing levels in the wake of the financial crisis are set against geopolitical tensions, the rise of China and a Russian nation still struggling with the break-up of the former Soviet Union. 

For investors, a £2 billion increase in its pipeline of work compared to this time last year and a tabled, if rejected, merger proposal from Serco (LSE:SRP), are perhaps cause for some optimism. A prospective dividend yield of over 5% (not guaranteed), covered more than twice by earnings, and a forward price/earnings (PE) ratio below both the three-and 10-year averages add further positivity. 

That said, the election of a new UK government has seen yet another defence spending review promised, with the shares down over 10% since 12th December, while the company is now temporarily without an established leader. 

Positives: 

  • Previous merger/takeover proposal from Serco – rejected by Babcock
  • Attractive dividend yield

Negatives:

  • Another defence spending review is pending
  • Without a chief executive

The average rating of stock market analysts:

Hold

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