Interactive Investor

Insider: defence contractor bosses reload shares

10th August 2020 11:36

Graeme Evans from interactive investor

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Two Babcock directors buy more shares in the firm, while dividends are axed and short sellers circle.

Share purchases by two directors at Babcock International (LSE:BAB) have offered a little comfort to investors after the defence contractor's “exceptional” decision not to pay a dividend.

A combined £38,000 worth of shares were bought by non-executive director Myles Lee and the spouse of chairwoman Ruth Cairnie on Tuesday, when the former FTSE 100 index-listed stock was languishing at a fresh 14-year low in the wake of its AGM trading update.

Babcock disclosed that operating profits for the first quarter were down by some 40%, with around half the reduction due to lower levels of productivity caused by Covid-19 disruption. Its services span marine, nuclear, land and aviation, with major sites including Devonport Royal Dockyard, the Clyde Naval Base and many Army and RAF land and air bases.

The update comes weeks after Babcock plunged to a full-year loss of £178.2 million, having booked a huge write-down at its aviation division to reflect the impact of the weaker outlook in the oil and gas industry for its operations flying helicopters to and from North Sea oil rigs.

Babcock is now focused on strengthening its balance sheet and reducing net debt, meaning that it definitely will not pay the 2019 dividend it suspended back in June. The company described the decision as exceptional but appropriate, given its use of the government's job retention scheme.

Cairnie has pledged to resume dividend payments at the earliest opportunity, adding that the pandemic had demonstrated the value of Babcock's programmes and focus on non-discretionary areas as a platform for medium-term growth.

It will be the job of David Lockwood to harness that potential, with the former Cobham boss due to join the board next Monday and replace Archie Bethel as chief ex on 14 September. Last month, Lockwood bought almost £300,000 of shares in the business.

He was appointed by Cairnie because of his wide-ranging knowledge of the defence and aviation industries, having also gained expertise in the use of technology and innovation during his spells in charge of Cobham and FTSE 250 index-listed Laird before that.

The size of the challenge facing Lockwood is highlighted by a share price that slid from a peak of 1,297p in 2014 to 613p at the start of this year and 261p earlier this month. Babcock is increasingly in the sights of short sellers, with almost 5% of shares out on loan, according to the latest figures from the Financial Conduct Authority.

The interest of shorters comes amid speculation that rising levels of government debt will put further pressure on Babcock due to cuts in defence spending.

Analysts at Jefferies cut their earnings forecasts by between 15% and 20% following last week's update, although they continue to have a ‘buy’ recommendation on the shares despite lowering their price target from 520p to 430p.

They have echoed the company's optimism about medium-term prospects:

“We believe management will prioritise deleverage and free cash flow, which could revive materially in the 2022 financial year if productivity recovers and cash exceptionals moderate.”

The shares were trading at a level well above 500p in January 2019, when outsourcer Serco made two unsuccessful attempts to merge with Babcock. That was before last July's arrival of Cairnie, who took on the role previously held by former BAE Systems boss Mike Turner.

She has extensive experience of the engineering sector after a 37-year career spanning senior roles at Royal Dutch Shell (LSE:RDSB). She is also on the board of Associated British Foods (LSE:ABF) and has been a non-executive director at Rolls-Royce.

Cairnie is a regular buyer of Babcock shares, having also made separate purchases totalling £88,000 in July. Last week's acquisition of 10,000 shares was made at a price of 251.9p.

It is remarkable to think that Babcock's market valuation of £1.4 billion from its work supporting warships and nuclear submarines is now less than half that of Games Workshop (LSE:GAW), a company selling dungeons and dragons-style fantasy games.

Shares in the maker of Warhammer figurines have been trading at a record high in recent weeks, although that has not stopped one of its non-executive directors from buying shares.

The purchase of £20,000 of stock was made on Tuesday by John Brewis at a price of 9,270p, compared with just 3,590p seen during the market sell-off in March. Games shares have roared ahead since then, with the recent publication of full-year results adding to investor excitement.

Chief executive Kevin Rountree described the figures as “amazing” after profits jumped by £8.1 million to £89.4 million, despite the disruption of Covid-19 towards the end of the period. 

Demand for its Warhammer figurines now comes from across the world, with the Nottingham-based business generating around 75% of its £269 million annual revenues outside the UK. 

Its market capitalisation of around £3 billion easily beats the smallest stock in the FTSE 100 index, which is currently ITV (LSE:ITV) at £2.5 billion. Games is also bigger than low-cost airline easyJet (LSE:EZJ), security group G4S (LSE:GFS) and energy company Centrica (LSE:CNA) in the FTSE 250.

These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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