Babcock International

Description

Babcock International provides highly-specialised engineering support services to a range of government bodies as well as private customers in the UK and internationally. Established in 1891, the company operates across four sectors – marine, land, aviation and nuclear, offering maintenance services as well as upgrading, running and managing essential and complex assets which include military and naval bases, submarines and jets.

Investment case summary

At its core, Babcock specialises in performing engineering work on complex and sensitive equipment and infrastructure, including assets owned by the Ministry of Defence. Often, Babcock is the only outsourcer with the requisite capability and consequently the business enjoys high barriers to entry and possesses an effective competitive moat.

Despite these positive business model attributes, Babcock’s shares have been materially de-rated by the market recently, in part due to concerns about Ministry of Defence spending cuts. However, we believe this risk has been overstated. Much of the work that Babcock carries out is essential and non-discretionary in nature, and it has growing presence internationally, which serves to diversify its revenue base.

The company is embedded in a wide range of long-term contracts and also has good visibility over its order book. This ensures a stable revenue stream and enables the business to efficiently manage costs, in turn offering high margins and generating substantial amounts of cash which are in part returned to investors through dividend payments. Importantly, these attractive characteristics have become increasingly under-appreciated over the past three years.

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Fund exposure
Income Focus Fund 1.75%

As at 31 October 2018

Segmentation
Geography United Kingdom
Industry Industrials
Themes UK domestic exposure

Source: Woodford

Share Price

Market Quotes by TradingView

Commentary

Good set of results

A good rest of interim results from Babcock International today, with modest growth delivered in operating profit (+1.4%), earnings per share (+3.1%) and dividend (+3.6%). Revenues were held back by disposals and currency headwinds but the business is expected to return to growth in the second half, and guidance of low single-digit growth for the full year remains in place.

The main negative in today’s results relates to its Magnox joint-venture decommissioning contract, which ends in August 2019. Babcock now assumes no revenue beyond this point which represents a 2% headwind to next year’s profits (illustrating the diversity of contracts the company is involved in). Elsewhere, Babcock announced write-downs with respect to its oil & gas business, which may prompt headlines but does not represent new news.

By contrast, cash flow performance was particularly strong and helped the business to further reduce leverage, from 1.9x net debt to EBITDA, to 1.6x. The company reiterated its focus on disposals and an increasing emphasis on the quality of earnings, but no major strategic changes were announced.

Alex Correia
20 November 2018

Mixed trading statement

A mixed trading update today from Babcock International, with positive and negative elements. Revenue guidance has been downgraded slightly, following a reorganisation at the Ministry of Defence, which has affected the timing of some work that had been expected to fall in the current financial year. We have spoken to management who confirmed that although this is frustrating, it is not indicative of any major changes to the programmes involved or a broader slowdown in the company’s UK defence business.

On the positive side, the weaker revenue outlook does not feed through to earnings expectations, due to an improving margin profile at the business. Meanwhile, balance sheet and cash flow guidance was reiterated, and the bid pipeline has increased in size again, suggesting that although revenue timing has been pushed to the right, order intake remains relatively strong, underpinning the medium-term revenue outlook. Overall, our investment thesis remains on track.

Alex Correia
20 July 2018

“A lot to like” in the financial results

Babcock reported a good set of full year results, demonstrating a material improvement in free cash flow, which was 30% ahead of expectations. Additionally, organic revenue growth is expected to accelerate to c.4% in the current financial year. Indeed, once the impact of Queen Elizabeth Class aircraft carriers is removed, the organic revenue growth was 5.3% in the 2018 financial year.

The group’s order book and pipeline are largely unchanged and visibility over next year revenues remains high. In particular, the increase in the bid pipeline to £13bn is encouraging, especially after remaining broadly stable at c.£10.5bn from mid-2015 to mid-2017.

Stephen Lamacraft
23 May 2018

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address 9400 Garsington Road, Oxford OX4 2HN.

Woodford Patient Capital Trust plc is incorporated in England and Wales, company number 09405653. Registered as an investment company under section 833 of the Companies Act 2006. Registered address Beaufort House, 51 New North Road, Exeter, EX4 4EP.

The Woodford Funds (Ireland) ICAV (the “Fund”) has appointed as Swiss Representative Oligo Swiss Fund Services SA, Av. Villamont 17, 1005 Lausanne, Switzerland. The Fund’s Swiss paying agent is Neue Helvetische Bank AG. All fund documentation including, Prospectus, Key Investor Information Documents, Instrument of Incorporation and financial reports may be obtained free of charge from the Swiss Representative in Lausanne. The place of performance and jurisdiction for all shares distributed in or from Switzerland is at the registered office of the Swiss Representative. Fund prices can be found at www.fundinfo.com.

© 2018 Woodford Investment Management Ltd.
All rights reserved.

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