There is no better sign of recovery in an industry than a flurry of major contract announcements. It shows decisions are being made, bosses are looking forwards and, crucially, money is being spent. The UK's outsourcing sector has been enjoying just such activity and outsourcing giant Babcock has been in the thick of it. In January, Babcock's bosses said the group had won new contracts and renewals with a combined value of £2bn since announcing half-year results in November. Chances are this isn't a blip and, more important, Babcock's share price does not reflect the boost to activity.
- Healthy order book
- Massive pipeline of bids
- Squeezing more out of the VT merger
- Good cash generation
- Short-term pressure on margins
- High levels of debt
Babcock is well-placed to benefit from any increase in activity. It has a key role providing engineers and planning for the Royal Navy's fleet, and manages the upkeep of a number of key military bases, such as the RAF's chief operating base at Brize Norton. With such close ties to the UK government, Babcock will always be exposed to a spending freeze, but the momentum seems to be building in the opposite direction.
In January, Babcock said its order book stood at a healthy £12bn, included in which is almost half its planned revenues for 2012-13. And its bid pipeline is almost gargantuan. It stands at £10bn, double its level of a year ago.
The detail is encouraging, too. The bid pipeline includes 20 contracts worth over £100m, two-thirds of which are for new work. True, as bids turn into new contracts Babcock's profit margins may come under pressure. Chief executive Peter Rogers describes how each contract has a life cycle – margins are tight as new staff and capital are deployed, but they widen as the contract matures and profit is booked and cash is generated.
Babcock's half-year results reflected this as its operating margin improved from 9.3 per cent to 10.2 per cent as a number of key projects, such as the Queen Elizabeth class aircraft carrier project, reached maturity. Quite likely margins will tighten in the year ahead as the flurry of new work comes through. However, there is no hint that margins are collapsing, so healthy revenue growth should drive profits and earnings higher.
BABCOCK INTERNATIONAL (BAB) | ||||
|---|---|---|---|---|
| ORD PRICE: | 753p | MARKET VALUE: | £2.7bn | |
| TOUCH: | 752-753p | 12M HIGH: | 767p | LOW: 534p |
| DIVIDEND YIELD: | 3.1% | PE RATIO: | 11 | |
| NET ASSET VALUE: | 258p | NET DEBT: | 73% | |
| Year to 31 Mar | Turnover (£bn) | Pre-tax profit (£m) | Earnings per share (p) | Dividend per share (p) |
|---|---|---|---|---|
| 2009 | 1.90 | 107 | 37.4 | 14.4 |
| 2010 | 1.90 | 129 | 46.3 | 17.6 |
| 2011 | 2.76 | 115 | 31.3 | 19.4 |
| 2012* | 3.34 | 280 | 61.9 | 21.3 |
| 2013* | 3.50 | 313 | 65.7 | 23.3 |
| % change | +5 | +12 | +6 | +9 |
Normal market size: 3,500 Matched bargain trading Beta: 0.7 *Peel Hunt estimates (profits and earnings are not comparable with historic figures) | ||||
Another reason why margins should hold up is hinted at by the client list. Babcock recently won a £200m contract with the BBC World Service, and is the preferred bidder for de-commissioning the Dounreay nuclear plant. These are blue-chip clients whose projects require highly-trained engineers, who are in short supply in the UK. Yet Babcock has access to a pool of specialist engineers and is a trusted partner for government projects. And rightly so. It is set to complete the refit of the nuclear submarine HMS Vigilant on time, and the Queen Elizabeth aircraft carrier project is ahead of schedule.
Also progressing well is the merger with VT. That acquisition – for £1.3bn in 2010 – didn't come cheap and increased net debt to £796m in September 2010, which was a risky 2.8 times more than cash profits. But the logic of the deal now looks clear. Babcock's bosses say that of the £50m cost savings the merger should generate by March 2013, £30m-worth are on track to be delivered in 2011-12. And broker Peel Hunt reckons there is potential to find extra savings.
Cash generation has also led to a rapid cut in borrowings. In the first half of 2011-12, Babcock claimed it turned 117 per cent of its underlying operating profit into cash and net debt fell to £679m, just two times cash profits. Broker Espirito Santo reckons net debt will fall to £632m by March 2013.
