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For years, Babcock International (LSE:BAB) shares were one of the laggards of the UK defence sector. Contract delays, cost overruns, high debts and accounting issues meant it significantly trailed the likes of BAE Systems and Rolls-Royce.
Yet while risks remain — it booked another £90m cost overrun provision on a Royal Navy contract — the FTSE 100 company looks a very different beast following heavy restructuring.
Babcock’s share price has rocketed 120% over the past year, giving it a place in the prestigious Footsie blue-chip index. Given that global defence spending’s tipped to continue soaring, can the defence giant keep up its recent impressive momentum?
Well-received results
Its share price was continuing to climb after the release of blowout full-year financials on Wednesday (25 June). They revealed a 10% rise in revenues — or 11% on an organic basis — which hit £4.83bn in the 12 months to March.
Babcock’s underlying profit margin improved to 7.5% from 5.4% previously. Underlying operating profit surged 53%, to £362.9m, even after accounting for that £90m provision related to its Type 31 frigate programme. On a statutory basis, profits were up 51% at £363.9m.
Underlying free cash flow was £153.4m, down from £160.4m in fiscal 2024. But net debt still dropped more than £62m year on year, to £373.3m, pulling down Babcock’s net-debt-to-EBITDA ratio to 0.3 from 0.8 previously.
This led the company to hike the full-year dividend 30% to 6.5p per share. It also plans to repurchase £200m worth of shares this year, the first buyback in its history.
Guidance raised
Today’s results show that Babcock’s thriving in a market that’s growing at a rate not seen since for many years.
As the firm’s chief executive David Lockwood puts it: “This is a new era for defence. There is increasing recognition of the need to invest in defence capability and energy security, both to safeguard populations and to drive economic growth.”
In acknowledgement of this, Babcock’s also raised its medium-term sales and margin guidance. It now expects to achieve average mid-single-digit revenue growth, and an underlying operating margin of “at least” 9%. This is tipped to rise to 8% in financial 2026, a year ahead of schedule.
Analyst Mark Crouch of eToro also commented: “With Babcock’s core income derived from long-term government contracts in naval, nuclear, and aerospace defence, the company is well-positioned to capitalise on what looks set to be a sustained period of investment.”
Is Babcock a buy?
The shares soared 13% on Wednesday’s update, taking its forward price-to-earnings (P/E) ratio to 22.3 times. This is substantially above a reading of 12-13 times it was trading on just a year ago.
As a consequence, it’ll have to keep performing strongly lest it experiences a potential share price correction. And there are risks to its impressive recent momentum, from prolonged cost overruns on key contracts, to broader supply chain issues and competitive pressures facing the broader defence industry.
Yet it’s important to note that Babcock’s still cheaper than many of its industry peers. BAE Systems and Rolls-Royce’s corresponding P/E ratios are higher at 25.5 times and 38.1 times, respectively.
On balance, I think Babcock’s a top stock to consider in the current climate, with fresh price gains very possible.
