Trading in line with expectations, outlook unchanged… share price jumps 5%. That was the shock twist in today’s trading update from engineering outsourcing firm Babcock International Group (LSE: BAB). Nothing to see here, move along please, investors thrilled.
Underlying trouble
Presumably they expected worse. That’s understandable, given that the FTSE 250 firm’s share price plunged 12% last time it updated the market in July, when it forecast slightly lower underlying revenue growth than expected. That was despite reiterating its underlying earnings guidance for financial year 2018/19, and stating that its bid pipeline was up £1bn to around £14bn.
The £3.57bn company also reported an order book and pipeline that remains unchanged at around £32bn (£18bn order book, £14bn pipeline). Around 87% of revenue is now in place for 2018/19 and around 57% for 2019/20, which gives investors a lot of forward visibility.
Second half winner
Management continues to expect low single digit underlying organic revenue growth at constant currency for the full year, with stable margins. Its underlying earnings guidance remains unchanged and revenue and cash flow performance will continue to be second half weighted. Management expects to continue to reduce its debt to an EBITDA ratio of around 1.4 times by the end of the year.
Babcock’s share price trailed down after the initial excitement, or should I say relief, because its investors have endured a rotten time lately, with the stock trading 35% lower than five years ago. Questions continue to be raised about its long-term contract accounting, lack of external board hires and cash conversion, as RBC Capital Markets recently noted, although with a forecast valuation of just 8.2 times earnings, many of these are priced in.
The yield is 4.4%, with cover of 2.8, which is also attractive. Earnings growth projections of 2% and 5% in the next two years may not suggest a shoot-the-lights-out stock, but this is a turnaround play to watch.
On the rebound
The share price of fellow FTSE 250 engineering company Meggitt (LSE: MGGT) has fared slightly better than Babcock’s, although hardly enough to catch the eye. It has jumped 26% in the last six months, helped by last month’s positive interims, which raised full-year organic revenue growth forecasts on better-than-anticipated first-half trading and strong order intake.
The £4.28bn company boosted free cash flow by 19% while cutting debt by 7%, and further pleased investors by lifting its interim dividend 5% to 5.3p. Meggitt specialises in high performance components and sub-systems for the aerospace, defence and energy markets. But trading at a forecast valuation of 16.2 after the recent share price bounce back means it’s no longer in bargain territory. A forecast yield of 3.1% with cover of 2.0 is nothing to complain about, yet nothing to get too excited about either.
Bargain buy
City forecasters reckon the company’s earnings per share could fall 7% this year, then rebound 10% in 2019. However, I can’t get too excited. After Meggitt’s recent share price spurt, it might be worth looking elsewhere. Of the two, I would buy Babcock first. It could just be a bargain.
