May was a good month for the FTSE 100 in general, and this high-powered growth stock in particular.
Shares in aerospace and defence firm Babcock International Group (LSE: BAB) climbed 14.7% over the month, beaten by only a handful of stocks.
This isn’t a one off. The Babcock share price is up 70% in a year, and 200% over two years.
Defence stocks have ridden a wave of renewed military spending across Europe, due to Vladimir Putin’s invasion of Ukraine and US President Donald Trump’s unpredictable response.
Strong result fuels rally
Is there more to come? Could be. Of the nine analysts giving one-year stock ratings, an impressive eight name it a Strong Buy. None say Sell.
Babcock’s latest full-year results, published on 23 April, helped set the tone for May.
The board anticipates an 11% increase in organic revenues to £4.83bn on a constant-currency basis. Underlying operating profit jumped 17% to £363m, lifting margins from 7% to 7.5%.
Babcock’s biggest gains came in its nuclear and marine divisions, areas where the backlog of orders remains healthy.
The firm converted roughly 80% of operating profit into cash and delivered £153m of free cash flow, despite an extra £40m pension contribution.
Revenue growth, profit expansion, and cash generation too – what’s not to like? The shares rallied as brokers lifted their outlooks.
Broker optimism
On 21 May, JPMorgan Cazenove nudged its price target up from 1,000p to 1,100p, and maintained an Overweight rating.
It now expects Babcock to deliver average annual earnings per share growth of 10% for the next five years. And with high visibility too.
The obvious concern is that Babcock doesn’t come cheap. Its price-to-earnings ratio is now pushing 30, edging ahead of fellow defence firm BAE Systems on 27.5 times. Any earnings miss could hit it hard.
Rolls-Royce, with its defence exposure (plus a lot more besides), trades on a P/E of almost 42 times.
Another concern is that Babcock shares have flown too high, and must ease off from here. That could be the case even if geopolitical concerns continue.
The eight analysts serving up one-year share price forecasts have produced a median target of just over 902p. If correct, that’s a small drop of around 3.5% from today.
New investment
PM Keir Starmer’s EU trade deal could give Babcock and other UK manufacturers access to a proposed €150bn European defence fund, potentially driving fresh investment.
I already hold both BAE and Rolls-Royce, both of which have done brilliantly for me. I’m wary of piling on yet more exposure at this juncture.
Babcock has had a splendid run but its pricey valuations appears to factor in much of the good news (given the state of the world, I should probably say bad news).
This stock has had a brilliant run, and given the geopolitical state we are in, I expect it to power on. But I also think the big gains have been made for now, so I’ll sit tight with what I’ve got.
