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Should I buy Babcock International shares?

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Babcock International (LSE: BAB) shares are cheap right now. The stock is trading on a price-to-earnings (P/E) ratio of 4x. It also generates a dividend yield of approximately 2.5%. So is now a buying opportunity?

For now, I’ll be monitoring Babcock international shares closely. But I do think the stock is worth taking a closer look at.

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Company overview

Babcock International has four main business divisions. These include Marine, Nuclear, Land and Aviation. The FTSE 250 engineering services company provides training for defence forces from the navy to the airforce and the army. It also has trained pilots and medical staff who provide aerial emergency medical services as well as aerial search and rescue operations.

Approximately 52% of its 2020 revenue was derived from the defence sector with the rest coming from the civil industry. And 69% of it sales were generated from the UK.

New captain

As I mentioned, Babcock International shares are cheap right now. In January, the company released a trading update, saying that it was seeing “a continuation of trends in the first half of the year” with weakness in its civil aviation businesses and a negative impact from Covid-19.

It also started a series of reviews in January. This included a review of its balance sheet and contract profitability. I think it’s worth adding here that that the new CEO, David Lockwood, joined the firm in September 2020. When there’s a new captain of the ship, it’s inevitable that there will be a review of the business.

But in my view, this isn’t a bad thing at all. A fresh pair of eyes is sometimes what a company needs and judging by the Babcock share price, that’s true in this case.

Business update

The company provided investors with a business update in April, the announcement being made ahead of its full-year results in July “to provide some early transparency on key issues”.

The main thing to note here is that the company will have to make significant write-offs and there will be a reduction in profitability. This business update was therefore a warning to investors of what lies ahead in the results report. 

It has said that its contract profitability and balance sheet review (or CPBS) has identified impairments and charges totalling approximately £1.7bn. That’s a huge amount and will clearly hit profits.

But the company also said that the “vast majority of the impact of the CPBS is one-off in nature and non-cash affecting”. So it’s short-term pain for long-term gain, it seems.

It has also stressed that it aims to return to strength without having to raise money through an equity issue. For now, net debt as a multiple of EBITDA is 2.5x. That’s on the high side for me.

My view

I wouldn’t buy Babcock International shares just yet. As tempting as the cheap valuation is, the company is yet to release its full-year results. Things aren’t looking great for the company. So I’m waiting for all the bad news to be digested by the market.

But the stock is certainly on my watch list. Under the leadership of the new CEO, things appear to be changing. And the various reviews are likely to be the start of a transformation. I’ll also be looking out for further details on the company’s next steps.

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Nadia Yaqub 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.

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