Half year results for Babcock International to 30th September 2017 are not only fully in line with forecast expectations but they clearly demonstrate that further excellent progress has been made in meeting various targets and objectives set.
In his half year statement, CEO Archie Bethel said that “The increasing number and value of our opportunities both in the UK and internationally, where we continue to gain traction, highlights Babcock’s long-proven ability to grow despite uncertain market conditions. Our focus on technology-intensive critical services where barriers to entry are high has consistently enabled us to generate sustainable growth regardless of any decline in spending on original equipment. I expect this to remain a key element of differentiation for Babcock in the coming months and years. We have excellent revenue visibility with 92% of budgeted revenue now in place for FY18, and we expect a slight improvement in overall group margin during the second half. We therefore remain confident that full year results will be in line with our expectations and that we will make further good progress beyond this year.”
All this is very encouraging and it questions why over the past year shares in Babcock International have fallen from 988p to just 716p in early morning trade this morning. Given the very long record of successful performance achievement, the benefit of having a more mixed international portfolio that is far less reliant on the UK today than it once was and also of what should, in my view, be regarded as excellent overall performance in the first six month of the year combined with yet another positive outlook, it is surprising as it is disappointing that the latest set of results has failed to excite investors.
The performance of Babcock International shares over the past year has certainly been disappointing. This to me is all the more so in the knowledge that international public sector outsourcing requirements are continuing to grow. Perhaps nowhere has this been better demonstrated over the past year than by the award of an eleven year EUR 500 million training contract with the French Air Force (l’Armee de l’Air) but other recent awards confirm the trend.
Whilst it is true the company is experiencing margin pressure in its very busy international firefighting activities following the temporary industry wide grounding of the type of helicopter used and that, due to the announced step down in nuclear decommissioning as the first round of MAGNOX reactor decommissioning draws to a close, these activities will remain stable at best, positives far outweigh negatives in the outlook period.
Again , while it is also true that some other support services sector companies have suffered from a variety of different issues and problems over the past two years and that as a direct result of this the sector has been dragged down and also that genuine concern exists in the UK defence industrial base with regard to future spending on UK defence equipment in the wake of a growing underfunded deficit in the defence equipment budget, I take the view that as a growing provider of support services contracts both in the UK and internationally Babcock International will continue to move from strength to strength. Thus I can only reason that the decline in Babcock International shares is the result of continued sector nervousness in the wake of competitor issues and that of defence cut expectations here in the UK and that regrettably have also been impacted by a recent profit warning from a mid-sized company within the defence equipment manufacturing sector.
Concern in relation to the likelihood of cuts in equipment procurement is not without justification of course and further base cuts are possible. But, being predominantly engaged in the provision of service support across a very wide area within the defence estate and, as demonstrated by the involvement in the Aircraft Carrier Alliance that has been responsible for building HMS Queen Elizabeth and HMS Prince of Wales together with Royal Navy through life support, operation of the two Royal Navy bases at Rosyth and Devonport together with that at Faslane, I suggest that future impact of any proposed defence cuts on Babcock International will be minimal.
Babcock International is also a 50% partner with Lockheed Martin in Ascent Flight Training Ltd and which has for the past four years been responsible for UK military flying training (UKMFTS) at RAF Valley in North Wales. Ascent has more recently been awarded the contract to deliver the rotary wing element of UKMFTS at RAF Shawbury through to the year 2033 and which is currently being worked up ahead of the start date next year. In addition to both the above, in February 2016 the Ascent joint venture was awarded the fixed wing element of future fast jet training that from 2019 will replace the existing Tucano based training at RAF Linton-on-Ouse.
All these are superb long term projects and given the high level of respect that Babcock International has earned over the years on existing contracts and for how it has worked so well with the military to ensure they have all that they require in respect of training capability, awards such as these are part of the growing relationship that the company has with the military. Babcock International is also one of the bidders competing in the UK Air Support to Defence Operational Training (ASDOT) Programme, the result of which is anticipated in the first half of next year.
It is also worth noting that in the five year period to 31st March 2017 Babcock International profits before tax doubled on revenue that was increased by approximately 50%. In itself this is a quite remarkable achievement and whilst it is not for me to predict future performance I do believe that confirmation within the interim results statement today that previous targets set have all been achieved and that combined with a positive outlook statement, the future for this company looks excellent.
Not only are underlying revenue and profits for the six month period up by 6% and 5% respectively and the interim dividend increased by 5.4% to 6.85p, but importantly Babcock have increased the bid pipeline to £12.2 billion from a previous £10.8 billion. The combined order book and bid pipeline has increased by c£1 billion to c£31 billion.
Other operational highlights for the period include completion of the sector realignment, confirmation that the French military air training mobilisation contract (FOMEDEC) and which is now underway, terms for the early ending in 2019 of the Magnox contract have now been agreed and that company has also been awarded the Technical Support Services Provisions (TSSP) contract for the supply of aircraft maintenance and operations, airfield support, vehicle fleet logistics and other related specialist services for the Royal Air Force worth an estimated £160 million for the first five years.
(Commentary will return next week)
CHW (London 21st November 2017)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785