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Babcock International – More Growth In Prospect By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

babcock_internationalHaving posted an impressive set of first half result numbers last week for the six period end September 2016 showing adjusted earnings per share up 7%, the raising the dividend by the same 7% percentage and with the company continuing to point toward expectations of growing international demand for the vast range of specialist, complex engineering support and other activities in which it is engaged it is pleasing to see a number of brokers placing shares of Babcock International back on the buy list.

In its forward outlook statement CEO Archie Bethel told shareholders that UK markets have continued to grow despite the broader uncertainties. He said that the UK Government’s five-year Strategic Defence and Security Review published last year had confirmed a commitment to invest in multi-year programmes, requiring the life extension of existing platforms, and a whole force approach. That is all extremely good news for Babcock International.

Having been with the company twelve years and previously head of the Marine and Technology division, Archie Bethel took over from long time CEO Peter Rogers exactly three months ago. In his report to shareholders Bethel said that the requirement in SDSR 2015 to generate £9 billion of efficiency savings across the MOD over the five year period covered by the review presented Babcock with significant opportunities for future growth just as does the continued drive for efficiency and performance across the civil sector.

These are remarks that I for one fully concur and having consistently delivered on the many contracts the company has with the MOD Babcock International is a shining example of how outsourcing of MOD activities to the private sector should be executed by the winning bidder. Unlike some other companies that the MOD has outsourced to, Babcock International can hold its head very high in the MOD for the benefits that it has provided to the customer and end user.

Examples that I could cite are many and include Royal Navy nuclear submarine support, at Faslane, Royal Navy surface ship support and maintenance at Rosyth and Devonport dockyards not to forget Babcock’s role in the two new carriers being built for the Royal Navy and which the company is a member of the Carrier Alliance. Babcock has an excellent record of delivering on time and on budget. Similarly in the air domain and in training Babcock have earned an enviable reputation for what they have achieved.

Fast jet training for the Royal Air Force and Royal Navy is another very interesting example of success and where Ascent, a partnership between Babcock International and Lockheed Martin, working with 1V(R) Squadron at RAF Valley have been conducting flying training since 2012 as part of the MOD’s Military Flying Training Systems (MFTS) programme. The success of this operation led to Ascent winning the UK MFTS Fixed Wing programme in 2014 and a year later, the Rotary Wing contract award.

The important point to recognise here is that Babcock’s proven expertise delivering complex programmes, through-life engineering services, fleet management, nuclear engineering support and technical training leave the company very well positioned to benefit from the growing markets for further outsourcing.

While the UK represents that larger element of Babcock International activities the company has sizable international interests as well. Here too the company has continues to witness an increasing appetite for output-based contracting and that can when properly done provide the end customer with proven efficiencies both in cost and availability across civil and defence customers. In his most recent report, Archie Bethel pointed out that countries such as Australia and Canada are increasing investment in multi-year defence programmes requiring through-life asset support, and that he believed there would be increasing opportunities for global alliances with trusted partners such as Babcock being asked to support customers in new geographies.

With a £20 billion order book in hand Babcock International has good visibility in respect of future revenues and confirmation in the interim results statement that the replenishment of the bid pipeline together with visible new opportunities underpins management expectations for continued growth

Of course, in a group of this size not all areas in which the company operates or engages in can be expected to be doing well all of the time. For instance, South African operations and that have long been in the Babcock International portfolio of interests have struggled recently due to the weak economy. Even so, I understand that small signs of progress are once again being witnessed. Similarly, with Mission Critical Systems being an operator of the aircraft, the European Safety Agency grounding of Airbus Super Puma helicopters following an incident off the west coast of Norway has caused a range of issues most of which have now been overcome.

Positives far outweigh negatives though and good interim results last week coincided with confirmation that, following a competitive bid process, France’s Direction Générale de l’Armement (DGA) has recommended that Babcock International should be awarded an 11 year contract to provide and maintain a training platform and related services for the French Air Force. Babcock’s share of the FOMEDEC contract is expected to be worth over EUR400 million of which around half relates to the financing of assets for the customer. Final contract award will be subject to the successful completion of the French Ministère de la Défense’s approval process, following the usual pre-contractual standstill period.

The publication yesterday of Sir John Parker’s independent National Shipbuilding Strategy report and that was requested by the Government could ultimately provide additional benefits for Babcock International. Whilst, as an independent report, the Government is not obliged to follow recommendations made, most believe that elements of the report particularly in respect of modular shipbuilding will see more commercial shipbuilding yards be given greater opportunities to work alongside the principle contractor in building a fleet of five smaller less capable frigates for the Royal Navy.

So what and who are Babcock International today. A FTSE100 Index stock and best described as being a vast engineering support services group that provides an extensive range of services to the UK Ministry of Defence, to other UK government departments and private sector industries such as those engaged in energy, transport, telecommunications, education and training. Another large activity that Babcock is engaged in is the provision of Mission Critical Services across many European states.

As the UK’s leading engineering support services operation I estimate that, excluding acquisitions completed during the last financial year, Babcock employ close to 35,000 staff, the majority of whom are highly skilled individuals engaged in managing in excess of £40 billion of key public service assets, supporting and operating complex equipment and infrastructure. The company provides engineering, technical and training services around the world.

With a long history, Babcock’s success is built on strong management, solid foundations and the consistent ability to read the market and, if necessary, adapt to change. With a deep rooted culture built on achieving performance and providing ultra-reliable engineering and service support excellence. This is a company that 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 Royal Navy dockyards MOD contracts represent in excess of 40% of group revenue. With annual revenue now in excess of £5bn, an order book of £20bn and with a bid pipeline estimated at £10.5 billion together with an excellent record of profit performance and growth together with good cash generation Babcock is no slouch when it comes to achieving excellent all round performance. Much of that is due to the brilliance of the now retired former CEO, Peter Rogers. New CEO Archie Bethel who I have known personally for many years is made of similar stuff.

Babcock has a long and 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.  However, I do not anticipate acquisition activity in the shorter term.

With operating returns on revenue exceeding 11% and with a strong cash conversion rate, excluding capital expenditure, consistently over 100% (80% including capital expenditure) while, following previous acquisitions, reduced net debt of just under £1.3 billion the company is well placed from a financial perspective.

Mission Critical Services which was acquired as Avincis in 2014 is the largest acquisition the company has made in recent years. Complicated in both structure, scale of operation and helicopter assets used, it is one that in my view will hold the company in very good stead for many years to come.

With annual revenue in the region of around £500m and market leading positions, this is one of the top three providers of mission critical operations in the world. The operations 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.

Babcock International is in my view very well positioned for future sustainable growth. Well managed and with market leading positions together with potential to benefit from many aspects of SDSR 2015 I look forward to continued strong performance from a company that as an analyst I have had the good fortune to observe closely for over thirty years.

CHW (London – 30th November 2016)

Howard Wheeldon FRAeS

Wheeldon Strategic Advisory Ltd,

M: +44 7710 779785

Skype: chwheeldon

hwheeldon@wheeldonstrategic.com

@AirSeaRescue

 

 

 

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