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H1 Results In-Line as Babcock International Positions Itself for More Growth By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

 

 

 

 

 

[I do not believe in re-inventing the wheel and thus I am very happy to repeat the statement made Archie Bethel, CEO of Babcock International and that accompany today’s First Half Results:

“Today’s results show we are doing what we said we would do. Our delivery in the first half is in line with our expectations, with good performance across most of the Group. In particular, strong performance from our Marine business has offset some weakness in the Aviation sector. 

“If we exclude the step downs resulting from big projects like the aircraft carriers coming to an end, and from the impact of procuring planes last year for the French Fomedec contract, our underlying revenue grew by 3.6%. This momentum, combined with the second half phasing of margin and cash flow that we expect, means I am pleased to confirm that the full year guidance we gave in May remains unchanged. 

“Our strategy is delivering – we have increased our order book to over £18 billion as a result of significant contract wins in our core markets, including building the Type 31 warship for the UK’s Royal Navy and providing training to London’s Metropolitan Police Service. We have continued to expand our international footprint, with new Aviation operations in Norway and Canada and the start of our support of the Australian Navy’s amphibious assault ships. And our pipeline of opportunities has increased to £16 billion as a result of increased bidding activity across our markets. Our combined order book and pipeline of over £34 billion is at its highest level ever”. 

“I am pleased with the progress we’ve made so far this year and we look forward to continuing to deliver our strategy through this year and over the medium term.” 

Although results were in line with previous expectations, given what the company are calling ‘step downs’ meaning contracts that have either come to an end over the past year or that are now in decline, that the company has managed to publish a flat set of revenue earnings is pleasing. As too the rest, I note that underlying operating profit of £251 million is based on the new IFRS 16 basis and that previous figures have not been adjusted. On a pre-IFRS 16 basis, underlying operating profit was £238 million, reflecting once again the phasing out of older contracts, on statutory revenue down 2.7%.

For the record, statutory operating profit at £168.7 million was higher than last year and which had included £120 million of exceptional charges. Underlying basic Earnings Per Share was 32.5p, Free cash flow £6.8 million (this reflective of anticipated phasing of operating cash flow through the year). The reduction in free cash flow when compared to last year mostly relates to the benefit of Fomedec working capital in the prior year. Net debt (pre-IFRS 16 basis) was £1,138 million at the half year-end and net debt (IFRS 16 basis) was £1,754 million. (Net Debt/EBITDA (covenant basis) was 1.9x. The Interim Dividend was raised by 1p to 7.2p.

In respect of the Financial Highlights during the first half year period, the Babcock statement emphasises a number of important issues. Firstly, that Half Year Results are in line with expectations particularly in respect of the anticipated phasing down of certain revenues in the FY19/20 year.

While underlying revenue of £2,458 million was undeniably flat after the impact of step downs is taken into consideration. Underlying operating profit of £251 million on the new IFRS 16 basis and £238 million on a pre-IFRS 16 basis was satisfactory. Statutory revenue was down 2.7% while Statutory operating profit of £168.7 million was higher than last year and which, as already mentioned, had included £120 million of exceptional charges. Underlying basic EPS of 32.5p and Free cash flow of £6.8 million reflects the expected phasing of operating cash flow in the first half period. The reduction in free cash flow compared to last year mostly relates to the benefit of Fomedec working capital in the prior year

In respect of Operational highlights, Babcock confirmed that the Combined order book and pipeline has risen 10% since March 2019, standing at £34 billion, its highest ever level. The Order book of £18 billion as of 20 November (March 2019: £17 billion) follows signing of the Type 31 frigate contracts that were signed a couple of weeks ago. 

Note that the order pipeline had stood at £16 billion as of 20 November (March 2019: £14 billion) with significant new Defence opportunities having been added in both UK and international markets. Major contract wins totalled c.£3.5 billion and include the Type 31 General Purpose Frigate programme. Additionally, the company has announced today the award of a new c.£300m contract for Metropolitan Police training. In respect of international expansion, the Babcock statement notes Increasing international presence in Aviation operations in Norway and Canada and also that group borrowings have been refinanced.

Outlook

The outlook for the year ending 31 March 2020 is unchanged. The company has stated that it expects underlying revenue to be around £4.9 billion and underlying operating profit (on an IFRS 16 basis) to be in the range of £540 million to £560 million – this being consistent with the previously communicated range of £515 million to £535 million which had been on a pre-IFRS 16 basis. In respect of margins, Babcock expect these to be unchanged except for the effect of the adoption of IFRS 16. The company expect free cash flow (post pension payments) to be over £250 million and expect to continue reducing net debt during the current year.

Strategy 

Babcock International continues a strategy based on Defence, Emergency Services, Civil Nuclear and a range of associated services.

The company had most recently outlined its strategy to investors at its Capital Markets Day in June but suffice to say that the main emphasis is to build on its core strengths, technology and expertise. Owned infrastructure and assets

Babcock had most recently outlined its strategy at the Capital Markets Day held in June 2019. The company has a strong and successful operating model and in essence, forward strategy is about further building on core strengths in the already achieved leadership positions and to continue focussing in Defence, Emergency Services and Civil Nuclear with the intention of growing revenue from these market fields from a current 75% to 85%. It is also to build further on its technology and expertise, owned infrastructure and assets.

The company is also seeking to grow international revenue from a current 30% of Group revenue today to over 40% over the next few years, developing multi-sector, multi-market opportunities in Australia, Canada, France and Spain. Embed technology is also seen to be a core growth driver across all four sectors. The bottom line is to grow earnings by 3% to 4% CAGR, to sustain margins at around 11%, increase cash flows each year in line with earnings and generate around £1.4 billion of free cash flow over the next five years. Importantly, the company intends to continue reducing net debt, increase flexibility, improve ROIC from FY20 and ensure sustainable dividend growth.

In respect of strategy delivery, the company is making good progress and particularly in supporting delivery of medium-term targets. Significant contract wins in our focus markets including the build of Type 31 General Purpose Frigates for the Royal Navy, Met Police training in Emergency Services and the MEH Alliance for new build in Nuclear. With a still growing order book and an order pipeline that is witnessing increased bidding activity across sectors, progress in running adjacent markets for value with revenue growth in the Marine and Land adjacent markets and an increasing market presence internationally (operations started in Norway, aerial emergency services in Canada) I would expect international markets, which currently represent 31% of underlying revenue, to further grow over the next few years. In addition, progress expanding multi-sector opportunities in the various target countries will obviously increase order pipeline opportunities.

Operational Comments: Defence

Revenue related to serving the UK defence market was higher in the period with growth in UK warship support and our technology businesses offsetting the impact of the QEC step down and the end of the Irish OPV contract, which was completed a year ago.

The Queen Elizabeth Class (QEC) programme is nearing completion with HMS Prince of Wales leaving Rosyth for sea trials during the H1 period. In addition to this, HMS Queen Elizabeth completed her first docking period in May with all contracted work completed at the company’s Rosyth facility.

The Type 23 frigate life-extension programme at our Devonport facilities continues at pace with multiple ships undergoing deep maintenance and structural upgrading work. In the period, the Type 23 iFrigate connected platform was trialled successfully on HMS Sutherland. The company has enjoyed strong revenue growth across the defence technology businesses with increased activity on weapons handling systems and higher volumes on our MSSP contract after last year’s slow start.

The US/UK Common Missile Compartment programme has continued well and, during the H1 period, additional orders were received to take our total contract to supply missile launch tube assemblies to over £230 million with further orders expected over the next twelve months. As already noted, Babcock International were awarded the contract for the Type 31 general-purpose frigate programme, which is intended to provide the UK with a fleet of five new warships. These ships will be assembled at Babcock’s Rosyth facility and importantly, will involve supply chains throughout the UK. Work started immediately following contract award with manufacturing commencing in 2021 and the programme concluding in 2028.

In respect of International Defence, Babcock has continued to make good progress on submarine and surface ship sustainment programmes in Australia and Canada and has completed a package of work for the US Navy in Oman alongside the company’s first UK Royal Navy ship. In Australia, the Naval Ship Management joint venture started work in July on the contract to sustain and support the largest vessels in the Royal Australian Navy: two flagship Canberra Class Landing Helicopter Docks (LHD) and their 12 associated amphibious landing craft.

The weapons handling systems business continued to progress on supplying the UK Astute and Dreadnought class submarines for the Royal Navy and that are being built by BAE Systems at Barrow in Furness. Progress was also made on the Jangbogo III Class vessel in South Korea. In addition, Babcock considers that they are well positioned to provide weapons handling systems for the new Attack-class submarine for the Australian Navy, work on which could be worth around £1 billion over the lifetime of the programme.

Adjacent markets: Energy and Marine Revenue growth was strong across the Energy and Marine businesses led by higher sales of the ecoSMRT gas handling system. The order book for the company’s LPG and ecoSMRT systems now exceeds £100 million. In April, the jointly owned ship MV Kairos (the world’s largest LNG bunker supply vessel) conducted its first ship-to-ship transfer.

Defence and Civil Nuclear

Defence Revenue grew across all UK defence business reflecting higher levels of activity in submarine support and design for new [Dreadnought class] submarine infrastructure required at Devonport. Performance on the key contract, the Maritime Support Delivery Framework (MSDF) remains in line with expectations, with efficiencies and cost reductions being delivered. During the period, the customer also confirmed that Babcock will continue work until the replacement Future Maritime Support Programme (FMSP) contract is developed and implemented. Both the continuation of MSDF and FMSP will be within the Terms of Business Agreement (TOBA) that runs to 2025.

The company continue to support the UK’s submarine fleet at both HMNB Clyde and HMNB Devonport. Activity levels in Clyde have been higher in the period as the company is working closely with the customer across three different submarine classes. In Devonport, work on the Revalidation Assisted Maintenance Period (RAMP) programmes for the Trafalgar Class continues and also the first life extension of the Vanguard Class submarine, HMS Vanguard.

Work has also started on the infrastructure design for the deep maintenance of Astute Class submarines in Devonport in the mid-2020s and Babcock is engaging with the MOD customer on various infrastructure upgrades at HMNB Clyde.

Civil Nuclear Excluding Magnox, revenue was slightly lower reflecting lower levels of customer activity, including unplanned outages with one customer. In respect of MAGNOX decommissioning, all remaining Magnox sites were handed back to the customer as agreed at the end of August although work at Dounreay continues to deliver on its revised scope. The company saw lower levels of activity in its nuclear services business during the period with lower levels of customer funding and some project delays at Sellafield. The last half year also benefited from projects completing.

Work on new build nuclear power stations continues to be a small but strategically this remains a significant part of our business. In August, the MEH Alliance (a joint venture with three other operators) was launched. This alliance will work across the Hinkley Point C site to integrate and coordinate the delivery of all the main MEH (Mechanical, Electrical and HVAC) activity. Babcock’s share of this work will be around £300 million over a five to six-year period starting in 2022.

The company continues to explore and develop international markets for Civil Nuclear and to that end has already won a first small order in Canada for consultancy work for nuclear waste management and decommissioning and they are exploring opportunities to expand this further.

Developments in Japan, where the company opened an office last year continue although progress is slower than expected with customer project delays. In respect of the outlook for the year ending 31 March 2020, Babcock expect some slight underlying revenue growth excluding the impact of the end of the Magnox contract (this now expected to be around £240 million). Even so, the outlook for margins remains unchanged, adjusting for the sector realignment announced in June 2019 and the company expect underlying margin to be similar to last year. The operating profit step down for Magnox is expected to be around £25 million.  

Defence – Land, Training Emergency Services, Rail and South Africa

Defence Revenue related to UK defence was higher in the period, mainly reflecting higher levels of procurement spend. The company has been working closely with the customer to refocus the Defence Support Group (DSG) Inventory and Repair Management service which provides around 285,000 lines of spares in support of the British Army’s vehicle fleet and we are investing in a new ERP system to drive further efficiencies in our vehicle maintenance and spares procurement activities.

Babcock are also working with the customer on a programme of Warrior vehicle overhauls over the next four to five years with this work scheduled to start in 2020. The ALC JV continues to perform well. Phoenix II, the contract to deliver over 16,000 administrative vehicles to the MOD, is performing well with significant reductions in vehicle numbers achieved through efficiency measures including increased use of telematics.

Across defence training the company we support the British Army in delivering training to around 20,000 service personnel. In the period we were awarded a three-year extension worth around £30 million for the Training Maintenance and Support Services contract. The Holdfast (RSME) joint venture, which provides training to the Royal School of Military Engineering, continues to drive savings programmes and the company is engaging closely with the customer as they develop their Collective Training Transformation Programme.

Emergency Services Trading across Emergency Services businesses was solid in the period on all contracts across the Metropolitan Police Service and London Fire Brigade. As mentioned earlier, during the period the company won a new contract worth around £300 million to act as the Met Police’s learning partner. The partnership to support the UK’s largest police service with its new training recruits will last at least eight years and will start in the next financial year.

The Land sector operates a range of contracts across markets adjacent to the company’s key markets – all benefiting from the established range of engineering capabilities and expertise. In Rail, Babcock has successfully completed the transition to the new 10-year CP6/7 contract for track works in Scotland worth up to £1 billion over the contract life and which is now fully operational. The company was also awarded a signals and telecoms contract by Network Rail to the value of £65 million over the next 5 years.

The company has made good progress across its Airports business with growth in existing contracts and we successfully rebid our Schiphol baggage maintenance contract for another five years. As anticipated, there has also been an improvement in the South African business (note that these are now the only remaining businesses in Babcock International that were in place forty years ago when the primary business activity of the company had been manufacturing of power generation equipment) with strong revenue growth excluding the £60 million impact of exits and disposals.

Aviation

Underlying revenue from aviation businesses was £515 million, £101 million lower than last year and which had included around £90 million of assets sales in the Fomedec contract, plus revenue from the Helidax joint venture which was subsequently disposed in March 2019. Excluding Fomedec and Helidax, revenue for the sector was only slightly lower despite contributions from new operations in Norway and Canada. Underlying operating profit of £66.0 million includes a £9.2 million benefit from the adoption of IFRS 16. Excluding this, H1 operating profit was £24.8 million lower than last year.

The lower operating profit and margin reflects the lower revenue together with a c.£5 million impact of Brexit-related costs that the company had flagged last year and in relation to comparison to some contract outperformances last year. Furthermore, Babcock state that they have seen some contract award delays in aerial emergency services in Italy and Spain as well as ongoing pressures in oil and gas.

The profit contribution from joint ventures was slightly higher with improved contract performances in AirTanker and Ascent (the latter being a joint venture company with Lockheed Martin) offsetting the end of contributions from Helidax.

In respect of the operational review, revenue in the Defence aviation businesses was down on last year given the impact of Fomedec equipment sales last year. Nevertheless, the company as made continued progress across its many military base businesses. The HADES contract, which provides technical support at 17 RAF air bases, has now been fully operational for a year and the Ascent joint venture performed well in the period with key milestones met.

In France, our Fomedec contract is fully operational with 17 PC-21 aircraft available on the flight line for Armée de l’Air Française.  All associated infrastructure and maintenance facilities are now in place and the contract has now moved to one of being full scale operations. Expanding services across international defence markets remains a key part of the Babcock strategy and this reflects a significant part of our pipeline, including defence flying training opportunities in Canada and France.

Aerial Emergency Services Revenue grew across most aerial emergency services operated and with the start of operations in Norway and Canada, combined with higher flying hours in Italian emergency services, offset by lower activity in Spain and lower than expected activity in firefighting operations across Europe. The company has also seen delays in the award of new contracts, particularly in Italy and Spain. These delays were a mix of rebids and new regions and were caused by customer decisions and appeals from other bidders. The first of these, a c.£50 million Italian emergency services contract, has now been re-won and as already noted, Babcock entered two new countries in the period.

The Norwegian fixed wing contract began operations in July with 11 aircraft providing aerial medical emergency services. Operations in Manitoba, Canada started in April and the company now manages, maintains and operates Manitoba’s fleet of seven firefighting amphibious aircraft and provide three of our own aircraft.

Babcock expect to make progress in the second half with our fleet optimisation programme in order to maximise cash returns.

In adjacent businesses, the Oil and Gas business continues to face challenging market conditions. Revenue was slightly lower in the period reflecting the loss of two contracts on price competition at the end of the last financial year.

CHW (20th November 2019)

Howard Wheeldon FRAeS 

Wheeldon Strategic Advisory Ltd,

M: +44 7710 779785

Skype: chwheeldon

hwheeldon@wheeldonstrategic.com

@AirSeaRescue  

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