If I wanted to invest in world-class British engineering then I haven’t too many options these days. But while the days of this country being a manufacturing powerhouse might be long gone, these types of companies are still alive and kicking. The FTSE 100 is home to big names like Rolls-Royce and BAE Systems and the FTSE 250 also includes a couple of interesting options to ‘bet on British’. One of those is the defence firm, Babcock (LSE: BAB), that’s been on a sterling run of late.
Turning point
Defence is undoubtedly a sector on the rise. The German chancellor called the Ukraine invasion “a historical turning point”, when it comes to how much countries are spending to protect themselves and the man might have a point.
In 2015, only three NATO countries spent 2% of GDP on defence. In 2024, 23 of them spent that much and plenty went well over. Babcock has enjoyed an uptick in orders from the spending, and the shares have risen 151% from a low in 2021.
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Poland now spends more than any other NATO member and some of that has gone to Babcock. It will oversee the construction of three Arrowhead 140 frigates, to be built in Polish shipyards with local workers.
These are big boats, 140m long with crews of 100. Over the coming years, they will generate $3.8bn, a serious sum compared to the 2023 topline of £4.4bn. The design is based on the Royal Navy’s Type 31 frigates that Babcock makes and could entice more parties to place orders.
Indonesia has already signed a similar contract and Poland is rumoured to be in the market for five more of the frigates too.
Supply chains
Those very same ships highlight what I believe is perhaps the biggest cause for concern here: supply costs. The Royal Navy ordered five frigates for £250m each. However, inflation and its effects on supply chains meant Babcock asked for another £50-£100m for the whole project.
The MoD weren’t too happy about this and the process went into dispute resolution. More broadly, this might be a worrying sign that energy and labour costs might affect operations like in the firm’s base in Plymouth.
With all that being said, the firm released a full-year trading update recently and it seems to be firing on all cylinders. The earning was a beat, coming in at £311m compared to the consensus of analyst expectations of £293m.
The order backlog rose by 8%, which means earnings growth is likely in the years ahead. Larger cash flows have sparked the resumption of a small dividend for the year too after several years without one. All told, this looks like a stock to keep an eye on. I’m adding it to my watchlist.
