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The Babcock share price crashed last week. What now?

Businessman looking at a red arrow crashing through the floor
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The Babcock International (LSE:BAB) share price has had a pretty volatile year so far. After plummeting by 25% in January, the stock soared by 37% in April. Then after a few months of relative stability, the share price once again crashed by 16% last Friday. And it’s down nearly 6% year-on-year. So, what happened? And is this a buying opportunity for my portfolio?

The collapsing Babcock share price

I’ve previously explored the historical volatility within the share price. But as a quick reminder, the engineering firm suffered through years of mismanagement and aggressive accounting. This is why the stock has been on a downward trajectory since 2014.

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While the original leadership is now gone, it seems they left quite a big mess for the new managers. Last week the company released its full-year results for FY21. And given that the Babcock share price dropped like a stone, I think it’s fair to say that investors were not impressed.

The company is undergoing a substantial restructuring that has caused quite a lot of pain. With managerial layers being eliminated and operations being streamlined, 1,000 employees are losing their jobs. Meanwhile, £1.3bn of goodwill and acquired intangible assets are being written off the books. Consequently, the firm reported a staggering £1.7bn loss for the year. So, I’m not surprised to see Babcock’s share price take a hit.

The Babcock share price has its risks

A potential comeback?

Seeing a record-breaking loss on the income statement is never a good sign. But in the case of Babcock, the underlying cause was predominantly due to a write-down of inflated asset values by the previous management team. Ignoring the effects of these expenses, the firm still reported a significant underlying loss of £363m. Taking a closer look, this negative impact stems from a sharp reduction in the gross profit margin, combined with a 5.5% drop in revenue.

That’s certainly not a healthy-looking business. But the worst might now be over. Asset impairments are a one-time expense, so losses should be significantly smaller moving forward. And the previously mentioned company restructuring, while unpleasant, is expected to tackle declining profit margins. Assuming margins rise again, the Babcock share price might do the same.

Like all unprofitable businesses, liquidity is a concern. However, after negotiating with creditors, Babcock secured a new £300m revolving credit facility for the next three years. Using debt to tackle debt is obviously not a sustainable long-term strategy. But it does offer some breathing space. In the meantime, the business plans to dispose of an additional £400m of non-core assets. These decisions should flood the balance sheet with sufficient cash to meet near-term obligations. That should allow the management team to focus on bringing Babcock, and its share price, back to its former glory.

The bottom line

From what I can tell, Babcock looks primed to start making a comeback. However, whether that plan will succeed has yet to be seen. Personally, I think there is currently not enough information about the firm’s future potential. So even though the recent drop in Babcock’s share price might be a bargain, I’m keeping the stock on my watchlist for now.

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Zaven Boyrazian 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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