Shares in British engineering company Babcock (BAB) are starting to recovery after a terrible period on the stock market.
The £3.9bn company saw its share price fall by more than 40% between September 2016 and February 2018 (from £10.90 to 626p) as investors feared it would be the next outsourcing company to fall foul of contract delays, political intervention and financial pressures.
Market sentiment now appears to be turning with the shares having rallied by more than 25% since February. And today they nudge up further still to 788.4p, helped by full year results meeting market expectations (albeit ones that were downgraded three months ago).
It has guided for revenue growth between 2% and 3%; and today we discover that it achieved 2.8% underlying growth to £5.4bn.
Pre-tax profit (also on an underlying basis) increased by 3.6% to £512.5m. The order book has slipped by 5.3% to £18bn but the bid pipeline has increased by 23.8% to £13bn.
RISK REDUCTION
Given that Babcock operates in military markets, there was some trepidation about the possibility of Jeremy Corbyn being elected prime minister if Labour won the next general election as he’s not a proponent of outsourcing military spending.
Joe Brent, analyst at broker Liberum, says this is less likely now following the local elections. This is good news for the company given that the UK public sector accounts for around 50% of Babcock’s profits.
The political threat aside, perhaps a more pressing problem for Babcock was the move to IFRS 15 accounting. These rules govern what revenue should be recognised and when. Outsourcers have typically used long-term contract accounting which allows a lot of discretion and has led to companies being quite creative with their accounting.
The introduction of IFRS 15 had a disastrous impact on Carillion with sector peers Serco (SRP) and Mitie (MTO) also impacted. However, for Babcock’s 2018 results IFRS 15 has not caused any change to contract revenue or profit recognition, suggesting a company is well run.
INTERNATIONAL PLAYER
Babcock has won new air ambulance contracts with Norway and Sweden as well as securing an Italian firefighting contract in January.
The company also has a French military air training contract in place, dubbed FOMEDEC as well as domestic RAF technical support services provision contract.
Liberum views the stock as cheap and data from Reuters goes some way to backing up that view, with Babcock trading at a steep discount.
Using Liberum’s forecasts, Babcock trades on 9.3-times 2019’s earnings. Reuters peer group average has a price-to-earnings average of 14.9-times. The company is also paying a prospective dividend yield of 3.9%.
