FTSE 250 share Babcock International (LSE:BAB) is ripping higher in midweek business. At 537p per share, the defence giant was last trading 8% higher on Wednesday (13 November).
It had touched near-five-year highs of 580.5p earlier in the session.
Babcock’s share price has soared thanks to forecast-topping third-quarter financials. My question now is can the business — which provides engineering services to the armed services and civil sector — keep this momentum going?
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Estimates topped
For the six months to September, Babcock enjoyed a 11% revenues bump to £2.4bn. This was better than the mid-single-digit increase City analysts had been tipping.
Its underlying operating margin declined to 7% from 7.1%, which reflected greater sales of high-margin AH140 frigate licenses the year before.
However, that sales jump meant Babcock’s underlying operating profit rose 10% year on year, to £168.8m.
Revenues at its Nuclear division rose 22% in the first half. This was driven by higher submarine support and refitting activity, along with growth in civil nuclear decommissioning and new-build businesses.
Sales at the Land arm, meanwhile, increased 8%, year on year. This was thanks in part to higher Defence Support Group (DSG) activity, where Babcock stores, maintains, repairs and upgrades UK military vehicles.
Strong outlook
It’s perhaps unsurprising that Babcock struck a chipper tone following its strong first-half showing.
Chief executive David Lockwood described Wednesday’s update as “another strong set of results [that showed] continued positive momentum across the group.“
He added that “a backdrop of geopolitical instability means demand for what we do continues to increase, resulting in an expanding and attractive long-term opportunity set.”
Babcock said that 90% of revenue for the full year was under contract at the beginning of October.
It kept full-year guidance on hold, and reiterated 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 next?
Today Babcock sources 74% of its revenues from defence customers, the lion’s share of which comes from the UK. It’s a figure I expect to keep climbing as the West rapidly rearms to counter what it perceives as growing threats from Russia and China.
The UK government has committed to raising arms spending to 2.5% of GDP, a level not seen since 2010. But defence expenditure may have to rise further after President-elect Trump demanded NATO members raise arms spend to 3% of GDP.
Babcock also provides services to other NATO members including France, Canada and Australia.
Still looking cheap
Despite today’s share price explosion, Babcock’s shares still look dirt cheap to me. It trades on a forward price-to-earnings (P/E) ratio of 12.6 times, which is well below the corresponding readings of other UK defence giants including BAE Systems (20.4 times) and Rolls-Royce (31.4 times).
On top of this, the firm trades on a corresponding price-to-earnings growth (PEG) ratio of 0.3. Any reading below 1 indicates that a share is undervalued.
This low valuation provides scope for further share price gains, I feel.
The company might not have things all its own way going forward. It faces high competition in a number of sectors, while supply chain issues (in the form of cost inflation and supply disruptions) remain a constant threat.
But I think it’s a top FTSE 250 share to consider, especially at current prices.
