• Stable order book
• Strong bid pipeline growth
• Debt pile falling
A trading update for the year to the end of March from engineering outsourcer Babcock International (BAB) revealed that the group's order book had merely remained stable at £12bn. Of more interest, however, was the growth of the group's bid pipeline – that increased from £14bn in January to £15.5bn at the start of April.
The most significant addition to the pipeline is a logistic and commodities services transformation contract with the Ministry of Defence (MoD). This involves supplying spare parts to keep the military moving and comprises a joint venture with DHL that's expected to be awarded in 2015. The MoD has valued the contract at between £6bn and £13bn – yet analysts think management has only included about a £1bn from this so far, which suggests that the pipeline is valued too conservatively at present.
More generally, management says that market conditions are positive, with progress being made in civilian and military divisions. Cash generation is also strong, with the ratio of net debt to cash profits expected to approach 1.5 times at the year-end – analysts estimate that means a reduction in net debt to around £595m, from £641.1m in 2012.
JPMorgan Cazenove says...
Overweight. Babcock is our preferred stock in the sector as we see it as having the most near-term earnings upside potential. Last month we pointed to a 'blue sky' scenario which envisaged 48 per cent EPS upside to our March 2015 estimate of 75.9p – news on the bid pipeline increasingly underscores that positive outlook. The main drawback is that the shares have re-rated and now trade on 16.5 times our 2013 earnings forecast, compared with Capita's shares on 16.1 times and Serco's on 14.4 times. That said, Babcock's shares are still more cheaply rated than the business services sector average of 17.1 times.
Espirito Santo says...
Neutral. We continue to believe that Babcock remains a low-risk earnings growth investment, supported by its scale and its agnostic approach to the equipment and infrastructure platforms that it maintains across the defence and industrial sectors. However, following a period of strong share price performance, these positives are now fairly reflected in the valuation. Babcock's shares trade on an enterprise value to trading profits ratio of 13.6 times for 2013 – we therefore retain our neutral rating with fair value set at 945p. Expect adjusted pre-tax profit to rise 17 per cent in the year to the end of March 2013 to give profits of £319.6m, EPS of 69.9p and a dividend of 25.9p.
