19 Nov 18. Babcock, the engineering services company, would like to provide clarification following a report by Sky News regarding exceptional items likely to be included in the Group’s half year results announcement on 21 November 2018.
As indicated to the market in its most recent Trading Update of 19 September 2018, Babcock is currently undertaking a programme to strengthen the Group by exiting a number of small, low-margin businesses, including the Appledore shipyard, and is reshaping its oil and gas business. We announced at that time that we would provide an update on these activities at our half year results. Whilst the exact impact of these actions has yet to be determined by the Board, we do not expect the net cash costs to be material.
Sky News Report
On November 16th, Sky News reported that ‘Babcock braces for £100m hit on North Sea helicopter arm.’
Babcock International Group, the engineering giant which maintains Britain’s nuclear submarine fleet, will next week try to draw a line under its recent difficulties by taking a £100m hit on the value of its helicopter business.
Sky News has learnt that Babcock is likely to announce as part of its half-year results next Wednesday an impairment charge relating to the Avincis operations it bought in 2014 for £1.6bn. The precise size of the writedown, which will affect the company’s profitability but will be predominantly a non-cash item, is expected to be decided at a board meeting early next week. One investor said the charge relating to Avincis was likely to be in the region of £100m, with analysts forecasting a number of relatively minor costs deriving from issues including the closure of the company’s Appledore shipyard in Devon, which was confirmed earlier this month.
City sources said that Babcock had decided to take the financial hit as it seeks to repair relations with the City following the publication of a bearish research note by a firm calling itself Boatman Capital. The Boatman note contained a series of allegations about Babcock’s management and finances, provoking a stinging response from the company, which said much of the content was “false and malicious”. A number of mainstream City analysts, including at Royal Bank of Canada, have also cast doubt on Babcock’s prospects in recent weeks, with its shares under pressure after sliding by nearly 25% over the last year.
Babcock, which is structured under four main operating divisions, is the Ministry of Defence’s (MoD) second-largest supplier, and runs a string of major contracts for all of the UK’s armed forces.
The company employs tens of thousands of people in Britain and has a market value of roughly £3bn. Its engineering expertise is seen as a vital asset in Whitehall, particularly because of the company’s role in maintaining the Vanguard class of nuclear submarines. The Financial Times reported this week that the MoD was seeking assurances that Babcock can complete a £200m overhaul of HMS Vanguard on time.
The purchase of Avincis was funded partly through a rights issue, but its performance was subsequently affected by an oil price slump which left much of its fleet under-utilised by a North Sea oil industry grappling with a steep decline in revenues.
However, the majority of the Avincis operations, which are generated from high-margin emergency medical and firefighting activities, have turned out to be a compelling growth business for Babcock.
The FTSE-250 company retains the confidence of its key public sector customers, and included a statement from a Government spokesman in a stock exchange announcement this week which said it remained “committed to working with [Babcock] on a wide range of programmes”.
The MoD spent more than £1.7bn with the company last year – a sizeable chunk of Babcock’s overall revenues.
Recent pressure on its shares have led some analysts to question whether Mike Turner, the chairman since 2008, may step down in the near term, but he said this week that he had no intention of doing so. One shareholder said on Friday that Mr Turner, the former boss of BAE Systems, enjoyed widespread investor support despite their shared frustration at its stock price performance. Babcock has sought to differentiate itself from peers in the support services sector by highlighting the skilled nature of its workforce and the loftier profit margins that it enjoys.
BATTLESPACE Comment: This announcement to in effect ‘steady the ship’ and the share price may be a temporary measure given the headwinds building about Babcock’s naval business, the Astute drydock in particular, and looming delays at its DSG land systems division where both the Warrior WCSP and Challenger 2 LEP programmes are facing delays, the latter for about 4 years. At the moment DSG does not seem to be well placed to benefit from other UK Land Programmes such as Ajax and MIV where both Rheinmetall and GDELS are creating their own support solutions. As our readers know we have been suggesting a write off on the £140m paid for DSG which was way in excess of bids from Dyncorp in particular.
Babcock shares reacted well to this Statement with the stock up 9.49p (1.62%) at noon to 593.69p. However, sources in the City suggest that with he burgeoning off balance sheet debt the shares may well be 300p in two years.
Will Mike Turner survive this hiatus or is it time for him to retire gracefully after a sterling career at BAE Systems, GKN and Babcock?
One possibility is a bid from BAE Systems for the submarine business which would put submarine manufacturing and support under one roof for the first time as happens in other countries. A merger was mooted some years ago but it is believed that the MoD did not like having so much power in the hands of one company.
Which of the low-margin businesses are up for sale has not been revealed, but it is likely that McNeilie will be on the block given that it has been moved to the Networks and equipment Support segment.
Other larger businesses may well be placed on the block to slim don the company and pay off debt to avoid a ‘Carillion like’ catastrophe.