Babcock’s full-year revenue grew by 10% to £5.3bn, ignoring exchange rates, driven by strong performances in its Nuclear and Aviation divisions.
Underlying operating profit rose 19% to £433mn, helped by the top line growth and widening margins. This excludes a one-off £140mn charge from its Type 31 ship-building contract, which experienced higher-than-expected costs due to late-stage design changes.
Underlying free cash flow improved by 71% to £262mn. Net debt fell by £44mn to £329mn.
For the year ahead, around 70% of the group’s revenue was locked in through contracts, a similar level to the prior year. Medium-term guidance was reiterated, with average revenue growth in the mid-single digits and underlying operating margins of at least 9%.
The group announced a new £200mn share buyback programme.
The shares were broadly flat in early trading.
Our view
Babcock’s full-year trading update was slightly overshadowed by a larger-than-expected £140mn charge on its troublesome Type 31 frigate programme. But aside from this, the group’s underlying performance was ahead of expectations, helped by strong growth in Nuclear and Aviation.
Babcock is a UK-based aerospace and defence company that designs and manufactures key military equipment across land, air and sea. The group’s Nuclear division owns and manages civil nuclear projects and supports the entire UK’s submarine fleet. Babcock also receives substantial revenue from providing support and engineering services, which can help smooth out peaks and troughs in large equipment orders.
With geopolitical uncertainty rising, governments around the globe are becoming more focussed on improving their defensive capabilities, and Babcock looks well-placed to benefit from this long tailwind and capture some of this extra spending. That’s already feeding through to a sizable order backlog of £9.6bn, equivalent to nearly two times last year’s revenue.
Recent financial performance has been impressive, with all segments except Land reporting strong top-line growth. Alongside improving margins thanks to contract renegotiations and efficiency improvements, full-year underlying operating profits jumped 19% to £433mn.
Nuclear continues to be the driving force behind the group’s performance, accounting for nearly 40% of total revenue, of which Defence accounts for the lion’s share. But nuclear energy is increasingly being seen as part of the solution to climate change and to improving energy security on the civil side. The market opportunity is huge, and with nuclear contracts typically lasting 5 to 10 years, that’s underpinning the division’s expectations for double-digit revenue growth over the medium term.
The latest charge in the Type 31 frigate programme stems from a design change that required complex late-stage rework on the first two ships. Although we can’t rule out further charges ahead, any future costs are likely to be much smaller, given that the rest of the ships are in much earlier stages of production.
The balance sheet’s in good shape, with net debt levels trending lower. And with strong cash conversion, the group’s forward dividend yield of 1.2% and new £200mn share buyback programme looks well covered. As always though, shareholder returns can vary and are never guaranteed.
All in, we think Babcock has a strong portfolio, with exposure to multiple long-term growth drivers. Strict regulatory requirements provide strong barriers to entry, helping keep competition at bay. Despite the run-up in valuation over recent years, we still see some modest upside on offer. However, because of its long-term contracts, supply chain disruptions and cost overruns are key risks to monitor.
Environmental, social and governance (ESG) risk
The aerospace and defence sector is high risk in terms of ESG. Carbon emissions from products and services and product governance are key risk drivers. Data privacy, business ethics, and security and labour relations are also contributors to ESG risk.
According to Sustainalytics, Babcock’s management of ESG risk is average.
Companies like Babcock involved in nuclear activities face significant safety risks and public concern over radioactive waste. While the group has a strong environmental management system in place, its radioactive waste management programme is an area for improvement.
Its ESG reporting standards are very strong, and there’s a robust whistleblowing programme in place. However, disclosure on product governance is a weak point, including how it investigates product safety incidents and corrective actions, and monitors product safety performance.
Babcock key facts
All ratios are sourced from LSEG Datastream, based on previous day’s closing values. Please remember that yields are variable and not a reliable indicator of future income. Keep in mind that key figures shouldn’t be looked at on their own – it’s important to understand the big picture.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by LSEG. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.
This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment.