Babcock’s in recovery mode and its shares are much cheaper than other defence stocks

The engineering support services group is a self-help story with significant rerating potential

As volatility returns, one way to protect your portfolio is to tap into returns that aren’t reliant on the global economy or the direction of markets.

We think Babcock International (BAB) is a good option as it undergoes an internally-driven, multi-year turnaround.

The engineering support services play has had a difficult time. However, Shares believes a rebound from October 2022 lows has further to run as Babcock benefits from self-help and a step-up in defence spending over the coming decade.

WHY BUY BABCOCK NOW?

The FTSE 250 constituent is at the start of a major recovery after several turbulent years, having been hit hard by additional costs during the pandemic. A specialist in managing complex assets and infrastructure in safety and mission-critical environments, Babcock swung from a £1.81 billion loss to pre-tax profit of £182.3 million in the year to March 2022.

This was the first year of its turnaround under CEO David Lockwood and chief financial officer David Mellors, who together successfully turned round defence outfit Cobham before its £4 billion sale to US private equity firm Advent in 2020.

Following the conclusion of a disposals programme designed to refocus Babcock on its core capabilities as a critical defence supplier to the UK and international partners whilst strengthening the balance sheet, defence now accounts for roughly two thirds of group revenue, and contract wins are coming through.

The backdrop for defence and security equipment and services providers has visibly improved due to Russia’s invasion of Ukraine and tensions between the west and China. This environment is favourable for Babcock, the

BABCOCK INTERNATIONAL (BAB)

Price: 328.8p

Market cap: £1.66 billion second largest supplier to the UK Ministry of Defence with a leading position in the UK maritime defence sector.

The company owns and operates complex marine engineering infrastructure in the UK and undertakes 100% of the in-service support and deep maintenance for the UK’s nuclear powered submarines fleet, as well as for a high proportion of UK surface warships.

Babcock Is Cheaper Than Other Defence Firms

Cost savings are coming through and margins are set to recover, driving positive free cash generation in the year to March 2024.

Based on Shore Capital’s 2024 and 2025 earnings estimates of 38.5p and 43.6p, Babcock trades on single digit prospective price-to-earnings ratios of 8.5 and 7.5, a discount to peers such as BAE Systems (BA.) and Qinetiq (QQ.) on double digit earnings multiples. This suggesting a rerating is overdue, while an imminent return to the dividend list offers an additional catalyst. [JC]