Babcock manoeuvres into calmer waters

“Like the ships we build, we know our company leaves a wake,” a short film played to investors at the start of Babcock International’s (BAB) half-year results exclaimed. The point was to highlight the group’s broader impact on the UK economy, but it’s a sign of how far turnaround efforts have progressed – 18 months ago, associating the company with a wake was to be avoided given the near-terminal state of its finances.

Babcock reported revenue growth of 1 per cent and a 13 per cent fall in pre-tax profit, although this doesn’t take into account the effect of disposals made to shore up its balance sheet. On an organic basis, revenue increased by 5 per cent and underlying operating profit by 10 per cent.

Babcock offloaded £447mn of assets in its last financial year – exceeding its £400mn target. So far this year, it has agreed the partial sale of an aerial emergency services business in July for £115mn and a civil training business in September. Both deals have yet to be finalised but once complete they will mark the end of planned asset disposals, chief executive David Lockwood said.

Net debt, although £300mn lower than the same period last year, has crept up by £70mn since its March year-end. The aerial emergency services sale should knock off a further £300mn – around £100mn in proceeds and £200mn in lease commitments.

Cash continued to flow out of the business, although at £24.7mn this was much lower than analysts’ consensus estimates of £136mn, according to Jefferies. The company is expected to be free cash flow positive in the second half.

Lockwood remained reasonably cautious on other measures, stating only that performance is in line with expectations. Although investors expected huge increases in government defence budgets following Russia’s invasion of Ukraine, these take time to filter through and uncertain macroeconomic conditions have tempered spending expectations.

Babcock’s relatively weaker balance sheet means its shares haven’t enjoyed the same bounce as others in the sector this year – they’re down around 3 per cent, compared with BAE Systems’ (BA) 45 per cent gain and Qinetiq’s (QQ.) 32 per cent rise. Its enterprise value of 4.6 times the consensus cash profit forecast of £442mn is well below its five-year average of 8 times. It remains in bargain basement territory for a reason, though – until it generates more cash, what will concern investors most will be Babcock’s debt. Hold.

Last IC View: Hold, 342p, 28 Jul 22