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BABCOCK INTERNATIONAL – BUILDING ON SOLID FOUNDATIONS By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

 

babcock_international01 May 15. A vast engineering support services group providing an extensive range of services to the UK Ministry of Defence, other government departments and private industry in sectors such as energy, transport, telecommunications, education and training and more recently, since the Mission Critical Services acquisition, foreign governments, Babcock International has little to prove when it comes to producing excellent financial performance and the ability to build and sustain on its already long record of successful achievement.

As the UK’s leading engineering support services operation I estimate that, excluding acquisitions completed during the last financial year, Babcock employ close to 28,000 staff, the majority of whom are highly skilled individuals engaged in designing, building, operating, managing and maintaining approximately £40bn of global assets. Many of these assets should also be considered key public services.

A company with a very long history I suspect that if I was to sum up Babcock it would be to say that it has never been stronger than it is today, that its success continues to be built on strong management, solid foundations and the consistent ability to read the market and adapt to change. With a deep rooted culture built on achieving performance and providing ultra-reliable engineering and service support excellence Babcock does not need to look over its shoulder.

Including training, support, maintenance and refit work on Royal Navy submarine and surface ship fleets, management and operation of Devonport, Rosyth and Faslane naval dockyards on long-term agreements suffice to say that the MOD represents approximately 45% of group revenue. With annual revenue probably in excess of £5bn, an order book of £20bn and with a bid pipeline estimated by the company at £13bn, an excellent record of profits performance and growth and excellent cash management this is no slouch when it comes to achieving excellent all round performance.

Babcock has a long and very successful record of acquisition integration and performance with some of the largest of these being the purchase of VT Group in 2010 for £1.5bn, Devonport Management Limited (DML) for £356 million in 2007, the acquisition of Avincis (now known as Mission Critical Services) for £1.6 billion in 2014 and latterly, the acquisitions of McNeillie for £55m and Defence Support Group (DSG) for £140m.

The Interim Management Statement (IMS) published in February this year confirmed that for the year to end 31st March 2015 all Babcock International businesses including Avincis had continued to trade well during the period and that overall the Group continued to experience strong demand for its services. Work on existing contracts and bidding and business development activities has remained buoyant and the outlook picture looks more than solid enough.

Having confirmed previous guidelines the IMS statement went on to say that the company entered the fourth quarter of the year (in January 2015) with an order book of c £20 billion and that this provided visibility of over 70% of anticipated revenue for the 2015/16 financial year. With a bid pipeline of c £13 billion, this combined to make a new high for the Group. Equally important, Babcock confirmed that it had maintained a healthy financial position and expected to have an operation cash conversion rate, excluding capital expenditure, of over 100% and including capital expenditure, of 80%. Net debt at the half year end stood just short of £1.3bn and the cash conversion rate was 115% of operating profit.

Investors have placed considerable attention on the Mission Critical Services (MCS) acquisition that was announced early last year. To provide greater clarity on the acquired organisation during March this year Babcock laid on an investor seminar which I attended. This was aimed at providing a better understanding and appreciation by the investment community of this fascinating business.

As a business Mission Critical Services has annual revenue of around £500m and is one of the top three providers of mission critical operations in the world. These cover fire, emergency medical, civil protection, search and rescue missions, helicopter transportation to oil and gas platforms, MRO, environmentally and other related missions across various parts of the world. Covering multi mission operations in multiple locations – Italy, UK & Ireland, Scandinavia, Australia, and right across Western Europe including France, Italy and Spain and in extreme environments the company has a fleet of 334 helicopters and 51 fixed wing aircraft operating 24/7. Gradual fleet modernisation and reduction in numbers of aircraft types (Spain for instance has 26 different aircraft types) can be expected to reduce costs over the years as will reducing operational complexity and better balancing the mix of acquired and leased aircraft.

As a growth business MCS was a typical Babcock acquisition not just because it came with market leading positions but also because it brought with it technological differentiation and a compelling business service that could be offered to existing and new customers. Well-structured as the market leader in the provision of integrated services that are both complex and bespoke to achieve further growth there would appear to be an excellent array of opportunities across all sectors of the emergency services sector and also as the oil and gas sector recovers as it is bound to do. On that score Babcock told investors in its IMS that due to the fall in the price of oil and gas there had been some delays in the award of exploration contracts that would impact on MCS but my view on this is that there are plenty of opportunities for gains elsewhere and particularly in the Emergency service sector which accounts for 70% of MCS business activity.

In terms of delivering growth opportunities other factors come into play here including market share gain, contract upgrade, extended use of outsourcing contracts by governments plus new country market opportunities. With excellent long term forward revenue visibility, a strong order book (c £2bn which is equal to 75% of estimated FY16 revenue visibility) plus a very good order pipeline MCS is an excellent addition to the Babcock portfolio and one that is already delivering excellent financial returns. It could also act as a very good portal to roll out other Babcock services in Continental Europe and beyond.

I suspect that the best of many good points that I can make about Mission Critical Services is to say that it is fully aligned with existing Babcock Group strategies. These include market leading positions, similar customer characteristics meaning central and local government and blue chip companies, customer focussed long term relationships, integrated engineering and technical expertise and requirements, a strong focus on health and safety plus a good balance between risk and reward.

It is not only fun watching CEO Peter Rogers together with his small but very efficient team of management colleagues expand Babcock but it is also rewarding from the point of view that this is not just a company with an excellent well defined strategy that has been expanding and improving profits consistently over the past ten years but also because this is a company that has rewarded its shareholders very well during that time.

Joining the company in 2002 as Chief Operating Officer and becoming CEO just a year later Peter Rogers has transformed Babcock by laying down strong foundations and building on a well thought out strategy. The Chairman is Mike Turner who is also chairman of GKN and a past CEO of BAE Systems.

To show the extent of change suffice to say that today there is only one subsidiary operation left in the Babcock International portfolio that was there when I started following the company as an analyst back in 1984. That business is South Africa which today represents around 7% of total Babcock International revenue.

The future certainly looks good for this company in my view and with integration of the newer businesses going very well I have few if any concerns other than the unknown of currency translation impact. Whilst one may of course worry about future defence spending in the UK and the potential long term impact on an engineering service support business such as this one compensation is surely that more business opportunities will emerge within defence as the MOD outsources even more of its inefficiently run requirements to save money.

Even so, it needs to remembered that Babcock has got very good clarity in its defence activities due in part to the separate TOBA (Terms of Business Agreement) it negotiated with the MOD. This effectively means that the company can still see at least ten years ahead in defence – a fact that means this is no bad place to be.

hwheeldon@wheeldonstrategic.com

Tel: 07710 779785

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