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BABCOCK INTERNATIONAL

BABCOCK INTERNATIONAL – STEAMING OVER THE BUMPS
By Howard Wheeldon, Senior Strategist at BGC Partners

09 Nov 10. Yesterday was certainly neither time nor place for a Babcock International non-executive director to voice criticism of a company with whom it is partnered or customer – in this case the UK government. For that unfortunate faux pas and because damage was inflicted on the company which until yesterday he happened to be Deputy Chairman Lord Hesketh has paid the ultimate price of becoming a ‘yesterdays’ man. Timing is everything so they say and however one views the substance of whatever it was that the noble Lord said coming just a day ahead of company interims was hardly a very good day to choose.

Back at the ranch despite innuendo and criticism by Hesketh of both SDSR and BAE Systems the good news is that Babcock International is actually doing very well. Having acquired the rump of VT Group earlier this year this very well diversified engineering based support services group managed to produce adjusted first half profits just short of £91m. This compares to just £71.8m for the corresponding period last year. With decent earnings growth, a still satisfactory outlook and order book, cash conversion that is put at 189% and net debt falling to £796m Babcock management chose not surprisingly to raise the dividend by a healthy 8%. It is though the future rather than the past that matters to investors and the management of a company such as this. Suffice to say that for a group that relies on the Ministry of Defence for around 50% of its revenue Babcock came through the recent SDSR process (Strategic Defence and Security Review) pretty well. That both planned aircraft carriers will be built and that the government will go ahead albeit somewhat later than originally intended with replacement of the submarine based nuclear deterrent is excellent news for Babcock. Moreover, as the Secretary of State for Defence indicated yesterday, the decision to delay Trident submarine replacement means that there will obviously be a significant increase in cost to the MoD of retaining the existing Vanguard class submarines based at the Faslane Naval base which Babcock Marine is charged with managing the infrastructure.

Clearly whilst SDSR had a less than dramatic negative effect on Babcock and the company will undoubtedly feel some negative effects of defence cuts it may at the same time benefit from the so-called return or incentive based procurement of services. Over the next few years in an attempt to save money by cutting the number of directly employed jobs we suspect that the government will shift more cost burden on to the likes of Babcock and other service based providers. For instance we suspect that Babcock is well positioned to take on any additional training work that might eventually be outsourced. On a wider view with VT Group now all but fully integrated and with the enlarged group held in high esteem by its government customer Babcock is in our view well placed to provide additional services to a government customer. In time the company may also attempt to play a larger role in long-term defence management related projects overseas. Clearly with some further shrinkage in the Royal Navy surface fleet there will over the years be less large scale refit work at Devonport and Rosyth yards. We are unconcerned about this believing that this resourceful company will over the years find new avenues to make better use of any underused assets. Equally important is that the other 50% of non defence related service revenue at Babcock is also doing well and to remember that this is not without additional growth potential either.

In nuclear decommissioning Babcock International has large scale expertise in storage and transportation of nuclear waste plus other hazardous materials. The company also maintains Tier one status in the UK military and civil nuclear market. With nuclear and hazardous waste subsidiary operat

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