Nine months into the CEO role, today is a very important one for David Lockwood. He is not the only new appointment at Babcock International of course and as can be clearly seen in the update statement, the arrival of David Mellors as Chief Financial Officer last November is also writ large across the what the company has told investors today. They had demanded clarity and transparency and as far as I am concerned, within what I regard as being a very clear statement of reality intent, CEO and CFO have provided this in spades.
Providing investors with a fulsome strategy and financial update ahead of full year results due next month alongside detailing from the ongoing ‘contract profitability and balance sheet’ review (CPBS) process is a sensible move. CEO David Lockwood told investors in a statement issued to the Stock Exchange this morning that:
“We announced a series of reviews in January and promised to report back on our strategic direction, a new operating model and a new financial baseline at our full year results. Today we give you an update on all of these areas. The early results from our reviews show significant write offs and a smaller ongoing reduction in the profitability of the Group. Through self-help actions, we aim to return Babcock to strength without the need for an equity issue. We are creating a more effective and efficient company through our new operating model and, in line with our new strategic direction, will rationalise the Group’s portfolio to help strengthen our balance sheet. Through our new operating model, the future Babcock will be a better place to work, a better partner to our customers and will be well placed to capture the many opportunities ahead of us”.
This is a very different Babcock International to the one that we have seen in the past, one that is determined to deliver and that accepts change is the order of the day. While it would be wrong to ignore the many successes achieved by the company over the past two years let no one be in any doubt that CEO David Lockwood and his senior management teams is determined not only to strengthen the company and position it well within a clearly defined strategy but also to create much needed transparency.
In respect to the initial results of the CPBS review process Babcock International says that it has identified impairments and charges totalling approximately £1.7 billion but importantly, that the vast majority of these are considered to be of a one-off nature and will be non-cash affecting. The company has also said that CPBS is expected to result in an ongoing reduction in underlying group operating profit of approximately £30 million each year.
The announcement in regard of CPBS has not surprisingly been welcomed by investors with a strong mark up in the share price this morning. Equally important to me is that the strategy announcement and confirmation that not only is the company planning to change its operating model in order to simplify and reduce various business layers.
The consequential says that the restructuring impact will lead to a one-off cash cost in the region of £40 million and which correspondingly, is expected to deliver realisable annualised savings of approximately a similar £40 million amount. Due to timing, approximately half of the benefit is expected to be seen within FY22 with the rest following in the years that follow.
Alongside is an intention to rationalise the Group’s portfolio by divesting certain businesses and which the company estimates will generate proceeds of at least £400 million over the next twelve months. From a balance sheet perspective, the company has made a clear statement that it intends to return the company to strength without the need for equity issue. In the statement Babcock International said that:
“We believe that a strong balance sheet provides resilience to the Group as well as operational and strategic advantages. After the completion of our various reviews, we will determine the appropriate capital structure for the Group which we believe we can achieve within the next 24 – 36 months”.
The divestment plan anticipates that disposal proceeds will be at least £400 million. Net Debt (excluding lease obligations) at the 31st March 2021 was £750m. Cash balances at year end stood at £533 million and this, combined with the undrawn element of our RCF provides liquidity headroom of around £1.2 billion. During the year the company repaid the US Private Placement of $500 million, hedged at £307 million, funding this from existing Group cash resources. The company has also stated that it is commencing discussions with its banks in order to secure protection to potential downside risks in its current planning assumptions.
The statement provides information including that draft unaudited management results show FY21 (year just ended to March 31st) show underlying revenue of £4,690 million (FY20: £4,872 million) underlying operating profit of £307 million (FY20: £524 million) – these before impact of CPBS. Results announced include share of joint ventures and associates.
Based on draft management accounts and the early view of the recurring impact of the CPBS, the Group’s net debt to EBITDA ratio at 31 March 2021 was 2.5 times. This is the measure used in the covenant in our revolving credit facility (RCF) and makes a number of adjustments from reported net debt and EBITDA.
In respect of further transparency and intended change the company told investors that net debt now includes balances related to the use of supply chain financing in the Group with extended credit terms and that amounts were previously reported in trade payables. At 31 March 2021 the amount included was £25 million, lower than the level last year. The intention is to phase out the use of supply chain financing across our Group. In addition to supply chain financing, the Group factors certain receivables in Southern Europe. These are non-recourse to the Group and so are not included in net debt. For reference, the level of receivables factoring at 31 March 2021 was £102 million (31 March 2020: £98 million).
Detail provided ahead of FY22 results publication includes that that the forward strategy will be based on international aerospace, defence and security activities and that with its leading naval business, now heavily engaged not only on support but also on building Type 31 frigates for the Royal Navy, that it intends to concentrate primarily on providing value added services across the UK, France, Canada, Australia and South Africa.
To that end change is the order of the day and while the strategy review announced back in November last year is ongoing (more details will be provided with full-year results confirmation next month) I will repeat below what the statement contains in relation to future intentions:
“Our UK defence businesses operate in an attractive market and have strong competitive advantages. Our Marine business has a range of platforms, systems and products that are highly competitive in international markets [and] we expect to play a crucial role as a strategic partner to the UK Government across key defence programmes including the Government’s 2030 vision for UK shipbuilding. Our international defence businesses have strong niche positions that will be further developed. We will focus on France, Canada and Australia.
The other markets we operate in vary in their attractiveness, ranging from the long-term opportunities of the civil nuclear market and a strong business in South Africa through to areas outside the core of what Babcock offers, for example civil training.
The Avincis acquisition in 2014 has not delivered shareholder value with low returns on high amounts of invested capital. We are selling our oil and gas aviation business and we are reviewing our options for the each of the aerial emergency services businesses.
A number of key enablers will be needed to execute our strategy including a new operating model, a new culture and people strategy, an innovation strategy and a stronger balance sheet supported by our disposal programme”.
CHW (London – 13th April 2021)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785