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FTSE 250 to share Babcock International (LSE:BAB) is up sharply in mid-week trading. At 537p per share, the defense giant ended trading 8% higher on Wednesday (13 November).
It touched a five-year high of 580.5p earlier in the session.
Babcock’s stock price rose due to higher third-quarter earnings forecasts. My question now is can the business – which provides engineering services to the armed services and the civil sector – keep this momentum going?
Ratings are high
In the six months to September, Babcock enjoyed an 11% rise in revenue to £2.4bn. This was better than the mid-single digit increase that City analysts were predicting.
Its core operating margin fell to 7% from 7.1%, which reflected higher sales of higher-priced AH140 licenses last year.
However, that sales jump meant Babcock’s underlying operating profit rose 10% year-on-year, to £168.8m.
Profits in its Nuclear division rose 22% in the first quarter. This was driven by higher submarine support and refit work, as well as increased nuclear decommissioning and new businesses.
Sales of the Earth arm, on the other hand, increased by 8%, year over year. This was thanks in part to the work of the Defense Support Group (DSG), where Babcock maintains, maintains, repairs and upgrades vehicles for the UK military.
A strong opinion
Perhaps unsurprisingly, Babcock scored a chipper ton following his strong first-half showing.
CEO David Lockwood described Wednesday’s update as “another solid set of results [that showed] he continued the good momentum in the whole team.“
He added that “The backdrop of global volatility means that demand for what we do continues to grow, leading to increased and more attractive long-term opportunities..”
Babcock said 90% of the full year’s revenue was under contract as of early October.
It kept full-year guidance unchanged, and reiterated that it remains on track to meet its medium-term goals of mid-single-digit annual revenue growth and underlying operating margins of at least 8%.
So what’s next?
Today Babcock derives 74% of its revenue from defense clients, the lion’s share of which comes from the UK. The number I expect will continue to rise as the West rapidly moves back to counter what it sees as a growing threat from Russia and China.
The UK government has committed to increasing arms spending to 2.5% of GDP, a level not seen since 2010. But defense spending may have to rise significantly after President-elect Trump demanded that NATO members increase their spending to 3% of GDP.
Babcock also provides services to other NATO members including France, Canada and Australia.
You still look cheap
Despite today’s share price increase, Babcock’s stock still looks cheap to me. It trades at a forward earnings ratio (P/E) of 12.6 times, well below the corresponding readings of other UK defense giants including. BAE Systems (20.4 times) and Rolls-Royce (31.4 times).
On top of this, the company trades at a relative price-to-earnings (PEG) ratio of 0.3. Any reading below 1 indicates that the assignment is not significant.
This lower valuation gives the opportunity for more share price gains, I feel.
The company may not have things its way going forward. It faces high competition in several sectors, while supply chain issues (in the form of inflation and supply disruptions) remain a threat.
But I think it’s a top FTSE 250 share worth considering, especially at current prices.
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