The Babcock International (LSE: BAB) share price crashed 16% on a trading update last Friday. The price continued to slide precipitously earlier this week, and the shares hit a 15-year low of 199p on Tuesday.
Could this FTSE 250 defence outsourcer be one of the biggest bargains in the market today? And should I buy it for a recovery?
When the Babcock share price was 675p
During 2017, I took a close look at a number of outsourcers. Namely, Carillion, Kier and Mitie. I found worrying signs of aggressive accounting, and balance sheets that were far shakier than they appeared on the surface.
I didn’t look at Babcock. However, towards the end of 2017, Morgan Stanley put out a research note suggesting there were similar issues at the defence outsourcer to those I’d found at Carillion, Kier and Mitie. A dive into Babcock’s accounts was enough for me to alert Motley Fool readers to the issues in an article titled This Neil Woodford favourite isn’t the only stock I’d sell today.
The Babcock share price was 675p at the time. Three years on, it’s around 70% lower. The company has a new chief executive (appointed last September) and finance director (appointed last November). So, is it ripe for a turnaround?
Last week’s Babcock share price crash
The trading update Babcock released last Friday covered the first nine months of its current financial year, which ends 31 March. The performance wasn’t great. Underlying revenue for the period was down 3%, and underlying operating profit slumped 34%. The company cited a negative impact from civil nuclear insourcing, Covid-19 and civil aviation.
Period-end net debt was £1.2bn (in line with its average over the nine months), while its current market capitalisation stands at £1.1bn
As to the full-year outlook, Babcock said: “Uncertainty remains around the outturn for this financial year, especially given that our fourth quarter is historically our strongest and that the Covid-19 situation has worsened in most of our markets.”
Management said it was giving no financial guidance for the year, due to the fourth-quarter trading uncertainty. But also because of one other factor. I view this factor as highly relevant to any investment at Babcock’s current share price.
The factor in question jumped out at me, due to my previous concerns about signs of aggressive accounting.
Babcock announced: “We have recently started a detailed review of our balance sheet and contract profitability. Early indications suggest that there may be negative impacts on the balance sheet and/or income statement for current and/or future years. This review is being supported by an independent accounting firm …”
Would I buy?
My reading of the situation is that the new chief executive and finance director have come in and aren’t comfortable with Babcock’s previous accounting. Hence the review, supported by an independent accounting firm.
I think any deep-cleaning of Babcock’s balance sheet is likely to reveal a company in a considerably weaker financial position than many investors currently imagine.
Given its debt and lack of earnings visibility, I find it easy to picture Babcock’s lenders making their continued support of the business contingent on an equity fundraising. Due to this risk of shareholder dilution, I see Babcock as a stock I’d avoid at this juncture.
G A Chester has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.