Babcock sales hit by delays in UK defence spending

Delays in defence activity will hold back Babcock's underlying revenue growth to "low single digits" this year.

The engineer said aviation sector growth is expected to be strong and having begun the process to sell off two low-margin "non-strategic" businesses and make other smaller disposals of non-core businesses through the year, said it was still confident of hitting its full year earnings and debt targets.

Directors expect to achieve its underlying earnings per share and cashflow guidance for the year and reducing net debt to a year-end ratio of 1.4 times EBITDA as previously guided.

So far, around 83% of expected revenue for the year to 31 March 2019 in place and around 55% for the subsequent financial year. The combined order book and pipeline increased to around £32bn from £31bn at the previous year end, with the order book of signed contracts little moved at £18bn and the pipeline of bids in progress increased to £14bn thanks to new marine bids.

But defence remains rather a medium-term concern, with revenues to be "temporarily impacted" by the restructuring of the UK Ministry of Defence's procurement organisation, Defence Equipment & Support and its newly created Submarine Delivery Agency, which is reviewing timings of its spending programme.

"Following this restructuring, a review of programme spend timings is contributing to slightly slower than expected UK activity levels in our Marine and Land sectors," Babcock said, with Marine revenues expected to fall in the first half.

In the Aviation division revenues were growing strongly and mobilisations were going well, while in Nuclear continues to progress delivery of the Magnox decommissioning contract and expects to have an ongoing role through multiple smaller contracts, as it does with Sellafield.

Shares in the FTSE 250 company fell more than 9% to 729.4p on Thursday morning.

The sum of this update will make just a little tweak to broker Shore Capital's forecasts, analysts said, expecting organic revenue growth of 1-2% and adjusting for the known step down in the Queen Elizabeth Carrier project this translates to around 5%, but with no change to EPS and cash flow.

Liberum also expected 1-2% revenue growth, or 4-5% on an underlying basis. "The shares may be down a little on weaker revenue but they still look too cheap," analysts said, adding that they expect news on Sellafield by year end.

Russ Mould, at broker AJ Bell, summed up investor concerns with Babcock over recent years. "It is highly skilled and works on some very important projects yet struggles to achieve decent earnings growth. Investors are increasingly worried about funding pressures at the Ministry of Defence which is Babcock’s biggest customer. There have also been concerns about regulatory moves reducing profits allowed on defence deals."

“Businesses need to keep growing sales at a decent rate each year in order to have a chance of producing excess cash that can help to pay down debt, if there is any, and support reinvestment to remain competitive.

“Admittedly Babcock looks to be in good enough shape to keep paying down its debt and there are signs of encouragement amid news of a £1bn increase in the pipeline of bids in progress to £14bn. You also have to consider that Babcock provides services that maintain essential infrastructure, so a lot of its work falls under non-discretionary expenditure.

“Yet the market wants stronger signs that the business has a healthy future and isn’t just ticking along.”