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Among other things, a growth stock’s expected to achieve a bigger increase in sales than the average for the industry in which it operates. And on this measure, Babcock International Group (LSE:BAB) just about meets this definition.
In its most recent trading update, the defence group said it’s expecting to report revenue of £4.83bn for the year ended 31 March (FY25), when its numbers are finalised at the end of June. If realised, this would be a 10% increase on FY24.
In 2024, according to the Stockholm International Peace Research Institute, global military spending saw the largest annual increase since the end of the cold war. With Europe and the Middle East leading the way, there was a 9.4% year-on-year rise.
A sector that’s booming
However, there’s an old expression in the world of business – ‘turnover for show, profit for dough’ – that emphasises the importance of earnings rather than sales. Here, Babcock’s doing particular well. If all goes to plan, it’s expecting a 17% increase in its underlying operating profit.
And I think there’s plenty of evidence to suggest that the group will continue to grow. From April 2027, the UK government’s pledged to increase defence spending to 2.5% of gross domestic product. And it’s declared an “ambition” to increase this to 3% in the next parliament.
According to UK public sector market intelligence platform Tussell, Babcock’s the second biggest supplier to the Ministry of Defence. During FY24, the group generated 70% of its revenue in the UK. The country’s strategic defence review’s expected to be concluded shortly and will provide recommendations as to how the extra cash should be spent.
Also, through its ‘Readiness 2030’ programme, the European Union’s planning to spend a further €800bn by the end of the decade.
Pros and cons
One broker’s particularly impressed by the way in which the group’s strengthened its balance sheet in recent years. Berenberg estimates that net debt’s now at 0.3 times EBITDA (earnings before interest, tax, depreciation and amortisation). At the end of FY21, it was 2.4 times.
The broker says this improvement gives the group the flexibility to invest further for organic growth, buy other companies, or increase returns to shareholders. It has a 12-month share price target of 910p, a 7.5% premium to today’s (16 May) value.
However, despite these positives, it must be acknowledged that investing in the sector can be controversial. On grounds of morality, many funds (and private investors) will not touch the industry with a bargepole. Others will claim that it’s the primary duty of a country’s government to protect its citizens.
Leaving aside these ethical considerations, I’m sure the recent share price rally will start to slow. Over the past 12 months, its shares are up 59%.
I also have concerns that the company’s Type 31 contract with the Royal Navy has resulted in nearly £200m of cost over-runs. That’s an enormous figure. The group’s chief executive blames continuing to work through lockdown and post-pandemic inflation.
But on balance, I think Babcock’s in the right sector at the right time. That’s why I recently bought some of the group’s shares. There’s an increase in global conflicts and, as a result, governments are looking to boost military spending. Therefore, as depressing as this backdrop might sound, it could be a growth stock for investors to consider.
