2nd Feb 2024 11:19
(Alliance News) - Clarity on the outlook for infrastructure and as well as progress on pension deficit will be what Berenberg is looking for at Babcock International Group PLC's capital markets day next week.
Berenberg noted the defence company is coming into Wednesday's update fighting fit.
"Babcock unveiled medium-term guidance in July 2023 and is tracking ahead of its targets," the German bank said.
It is Babcock's current management's maiden capital markets day, and the firm's first since 2019. The company is July said that in the medium-term, it is targeting an underlying operating margin of at least 8% and average annual revenue growth in the mid-single digits.
Babcock's pension deficit, its margin outlook and infrastructure programmes will be in focus next week, Berenberg explained.
The outlook for infrastructure will be particularly relevant, given the investor day will take place in the Devonport dockyard in Plymouth, Europe's largest.
"Babcock is spearheading a major upgrade programme of the site to prepare for the next class of UK submarines. This work now accounts for 10% of group revenue following very strong growth since 2021," Berenberg said.
Berenberg noted Babcock is guiding for a "decline in this infrastructure revenue" in financial 2025, which runs to March. The German added that Babcock "tends to guide conservatively on this", however.
"Continued outperformance versus guidance would offer mid-single-digit upside to group earnings before interest and tax," Berenberg added.
Elsewhere, Babcock's pension deficit, which stands at GBP300 million, is a "lingering overhang for the stock".
"Medium-term free cash flow is burdened by sizeable pension reduction cash payments. We estimate FCF in financial 2024 and 2025 would be 60%/50% higher if these were to cease," the German bank added.
"Management remains committed to reducing the deficit, either through self-sufficiency means or potentially through a buy-in. The significant reduction in leverage since 2021 increases scope for such action, in our view. Any progress on this front at the capital markets day is likely to be well received, assuming sensible financial terms aided by the current more favourable interest rate environment."
Finally, margin improvement will be something Berenberg is after some clarity on next week. Babcock is phasing out some low-margin legacy work, the German bank added.
"A key driver of margin improvement over the next few years will be the gradual decline in the contribution of low- to zero-margin legacy programmes. In FY23, these accounted for [around] 11% of group revenue, although the share will fall to 0% by FY29. This mechanical reduction in the share of low-margin contracts will add 60 basis points to group Ebit margins by FY27, making it an important component to reaching the medium-term guidance, under our estimates," Berenberg explained.
The German bank believes Babcock shares are still "attractively priced", sitting at a 30% discount to peers in UK defence.
It backed its 'buy' rating for the stock and its 510 pence price target. Babcock shares rose 0.5% to 454.40p each in London on Friday morning.
By Eric Cunha, Alliance News news editor
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