Buy Babcock's growth potential

The group's support services division, which accounts for a fifth of profits, is a key driver of the group’s strong organic growth, which came in at 12 per cent on a constant currency basis in the year to the end of March. The division grew its operating profit by a fifth to £100.9m during the year and produced organic revenue growth of 23 per cent.

The involvement of the support services business in the UK's nuclear industry, via its Cavendish Nuclear subsidiary, is yielding rewards for Babcock. In September last year it was formally awarded the decommissioning contract for 12 Magnox nuclear sites across the UK. Its involvement in cleaning up the Sellafield nuclear site will also generate long-term revenue for the group. In partnership with Balfour Beatty (BBY) it is constructing a major new decommissioning facility at the site. Meanwhile the AMEC/AREVA/URS consortium that operates Sellafield is likely to award around £4bn of contracts to tier two suppliers over the next few years. As the largest of these suppliers, Babcock stands to win big.

The group also services working nuclear facilities and in January signed a £600m 16-year deal to provide fuel route and other technical services to French energy group EDF's seven nuclear stations and pressurised water reactor for the rest of their operational lives. It has also submitted a bid for the 'balance of nuclear island' work at Hinkley Point C, the first nuclear power station to be built in the UK for a generation.

One of the benefits of these nuclear contracts is their longer-term nature which boosts revenue visibility, while the specialist skill needed to undertake them protects margins. What's more, as the popularity of outsourcing services has grown among both the private and public sector, so too has pressure on outsourcers’ margins from increased competition. Babcock has sought to differentiate itself by operating in technically sophisticated areas, such as nuclear, in order to safeguard its margins.

Another example of how Babcock is benefitting from its high-barrier-to-entry work is last year's 14 per cent organic growth delivered by its marine and technology division, which accounts for a third of group profits. It is benefiting from lucrative Ministry of Defence work and in September the group signed the Maritime Support Delivery Framework, confirming the continuation of its contract servicing HMNB Davenport and Clyde through to 2020 and valued at £2.6bn.

However it’s not all about organic growth. Babcock also has a canny approach to acquisitions. Twelve months ago the group acquired international helicopter services business Avincis, renamed Mission Critical Services (MCS). More than two-thirds of MCS's work comes from the emergency services market, where management sees the potential for further outsourcing. The acquisition has worked wonders for Babcock, increasing cash profits for its international division by just over 400 per cent to £117m.

Investor concerns around the potential impact of the weak oil and gas sector have also proven unfounded. MCS reported revenue growth of more than a fifth since its acquisition to £536.9m. The oil and gas sector accounts for a quarter of the business’s revenue stream. While services to the UK’s North Sea may decline over the longer-term as production reduces, MCS is making inroads into Mozambique and Australia with the help of Babcock’s regional teams. Chief executive Peter Rogers said he doesn’t expect headwinds from the sector to impact Babcock, and expects greater collaboration between MCS and its UK business on projects in the future, with the former’s contacts with international governments and clients helping the group expand its overseas footprint.