Babcock makes progress in fortifying balance sheet

Defence contractor Babcock (BAB) is making progress in repairing its balance sheet, having sold off three businesses worth £400m in recent months.

Net debt reduced marginally to £1.35bn during the period, but will fall further once the proceeds of recent sales are accounted for. Debt excluding operating leases stood at £938m at the end of September, or 2.8 times Babcock’s cash profit. The £290m sale of engineering consultancy Fraser Nash to US industry giant KBR in October effectively reduces this figure to 2.1 times and the company's near-term target is to cut this below 2 times.

Restatements made earlier this year to last year’s figures to more accurately assess contract profitability – which includes a £761m prior-year goodwill write-down – make some comparisons meaningless, but the company said on an underlying basis its operating profit rose 36 per cent to £115m as its margin increased to 5.2 per cent, up from 4.1 per cent, as several business units faced fewer Covid-related disruptions.

Chief executive David Lockwood, who was appointed in June last year to lead a turnaround of the business, is clearly taking some difficult decisions.

For example, there was a £160m free cash outflow as Babcock stepped up efforts to repay creditors and the company increased capital expenditure by 51 per cent to £72.1m to fund new work.

He also has some laudable goals, such as simplifying Babcock’s structure and making environmental, social and governance (ESG) a key part of the company's strategy – although it is difficult to imagine some investors will ever consider a defence contractor to be an ‘ethical’ business.

But the task of fixing Babcock is far from over. The company is spending £40m on restructuring over the course of the year and more asset sales are likely in the second half. Until a clearer picture emerges of the business's long-term future, it's one to avoid. Sell.

Last IC View: Sell, 277p, 30 July, 2021