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Unless you own shares in Babcock International Group (LSE:BAB), the FTSE 100 defence stock, the news over the past few days has been very depressing.
On Monday (2 June), at the launch of the government’s strategic defence review, the Prime Minister promised to make Britain “battle-ready” and the Defence Secretary talked of a “new era of threat”.
And if that wasn’t enough, ahead of the defence review’s launch, Sky News was simulating a Russian attack on the UK.
A silver lining
But so far this week, Babcock’s share price has soared 12%. Not surprisingly, the prospect of additional military spending has gone down well with investors. However, this impressive performance isn’t a new phenomenon. Since June 2024, the group’s nearly doubled in value.
And there could be more to come.
The government’s committed to spending 2.5% of gross domestic product on defence from April 2027. It also has an “ambition” to lift this to 3% by 2034. Reports suggest NATO’s pushing its members to reach 3.5% by 2035.
An attractive price
However, Babcock stock is now changing hands for more than the average 12-month price target of analysts.
The consensus of brokers is that the company is worth 869p a share (range 730p-965p). At the time of writing (4 June), the group’s share price is 1,068p – 23% more.
But even after the recent rally, the group’s current market cap doesn’t appear to be out of line with its peers. The stock’s trading on 23 times expected earnings for the year ended 31 March 2025 (FY25). Based on the FY27 forecast, the multiple drops to 19.
The equivalent FY27 figures for Rolls-Royce Holdings and BAE Systems are 27 and 21, respectively.
Not for everyone
However, investing in the industry is controversial.
I justify it on the basis that I believe it’s the first duty of government to protect its citizens. Indeed, I recently took a position in Babcock.
But I know others disagree with my stance. And this means there’s a smaller pool of potential investors — which could restrict future share price growth — although this week’s events suggest many are prepared to buy into the sector.
Well placed to take advantage
They might have made a decision to invest because they believe Babcock’s likely to benefit from the government’s plans to spend more on its nuclear submarine fleet, which the group helps to look after.
In addition, it’s a major supplier to the British Navy. The strategic defence review says: “An ‘always on’ supply line for shipbuilding is essential to retain industry skills and reduce the delays in delivering new ships that otherwise lead to additional support costs for ‘running on’ ageing platforms”.
But the group didn’t manage its Type 31 frigate contract very well. At 30 September 2024, it had incurred £190m of cost overruns.
Also, its dividend is tiny. Based on amounts paid over the past 12 months, the stock’s currently yielding 0.5%. Although, I expect this to increase when the group’s FY25 results – and final dividend — are announced on 25 June.
However, with an order backlog of £10.1bn and the US less willing to fund Europe’s defence, Babcock’s earnings prospects look strong. The stock also looks to offer better value than its two closest FTSE 100 rivals.
Therefore, I think it’s a share that long-term growth investors could consider.
