It’s been a long time coming, but Babcock International (LSE: BAB) finally admitted last week that some of its contracts will be less profitable than expected. The news sent the Babcock share price up by more than 30%.
This may not seem an obvious result, but the market cheered news that the company doesn’t need to raise extra cash. And although a 30% rise in one day is a big move, Babcock shares are still worth 20% less than they were one year ago. I think there could be more upside here.
Babcock share price: from zero to hero?
I think it’s worth taking a quick step back to understand the situation at Babcock. This FTSE 250 company carries out a lot of work for the UK navy. It’s in charge of maintaining nuclear submarines, for example.
However, Babcock’s share price has fallen by 75% since 2014, due to long-running concerns about the profitability of its business and the price paid for some acquisitions.
Two chief executives have departed the firm during this period, but I think new boss David Lockwood is determined — and hopefully able — to sort out the mess. A review of contract profitability will see the company take a £1.7bn write-off charge to value its contracts and assets more accurately.
Moving ahead, Mr Lockwood plans to sell non-core operations to focus the group more closely on defence and engineering work only. Around £400m of asset sales are planned over the next year, which should also help the group to cut debt.
The changes announced last week are expected to cut Babcock’s underlying operating profit by around £30m a year — perhaps 10%. But I think they should improve the quality and profitability of the business.
Even after last week’s share price rise, Babcock stock is still only trading on around eight times forecast earnings. I think this could be a decent turnaround play, with further gains possible. I’d consider buying Babcock for my portfolio at current levels.
Ted Baker: fashion fixer-upper
The Ted Baker (LSE: TED) share price rose by 25% last week, taking the stock’s 12-month gain to more than 40%.
Unlike with Babcock shares, Ted’s surge was not triggered by news from the company. Ted Baker hasn’t issued any updates to the stock market since early March.
Instead, I think that last week’s gain was linked to the 12 April reopening of shops in England. Ted Baker’s sales had been hit hard by store closures, with revenue down by 47% for the year to 30 January.
Ted Baker’s fashion ranges are biased towards occasion-wear. This wasn’t a big seller in lockdown. Even so, I think the online performance was very disappointing. The group’s e-commerce sales fell by 1% last year, during a time when most retailers reported strong online growth as they pivoted to lockdown-friendly categories.
Reopening stores should help to boost sales, but I think online performance needs to improve too. However, what really matters is if the brand can recapture the fashion success it enjoyed under founder Ray Kelvin.
I reckon Ted Baker remains firmly in turnaround mode. City forecasts suggest that sales will rise by around 35% this year. Even so, another year of losses is expected.
This situation is too speculative for me. I see no way to predict the likely outcome. Even after last week’s strong gains, I’d still prefer to buy Babcock shares.
Roland Head 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.