Berenberg downgrades Babcock to ‘hold’

Berenberg downgraded Babcock on Thursday to ‘hold’ from ‘buy’, pointing to the fact the shares have re-rated since it initiated coverage in 2022 and now adequately price in the benefits of the company’s strategic turnaround.

"The shares have re-rated by 65% during this time, reflecting the much stronger balance sheet and more focused portfolio," it said.

It noted that Babcock has disclosed a further £90m charge on the Type 31 frigate programme, following the £100m charge disclosed in FY23. The charge stems from higher-than-expected labour costs and the maturing of the design of the vessels, it explained.

"The programme is the last remaining large onerous contract within the group," Berenberg said.

"It represents only circa 5-6% of revenue, although it is an increasing cash drag and concerns that there will further charges on the programme may weigh on sentiment in the medium term, in our view.

"We are also mindful that higher-than-expected labour costs may not be an issue confined to the Rosyth dockyard, and that this could reduce the pace of margin expansion in the remainder of the group."

The bank said it would turn more positive on the shares again on evidence that the Type 31 frigate contract has been de-risked and signs that the pension deficit overhang has been further reduced.

Berenberg lifted its price target on Babcock to 565p from 510p

The bank said its preferred UK defence stocks are buy-rated QinetiQ and Chemring.