Market anticipating profit warning from Babcock, analyst sees opportunity

Following BT's shock profit warning linked to a deteriorating outlook for UK public sector work, broker Shore Capital wondered "when will Babcock warn?"

Babcock's shares fell around 2% on Wednesday as investors read across the implications from BT and had also fallen in sympathy with Capita when it warned on profits last year.

With circa 70% of the group de-facto dependent upon the UK public sector, ShoreCap felt the market was expecting a similar warning from Babcock, even though the profile of services delivered and the infrastructure supported is "more than a little bit different" to BT and Capita.

"Babcock supports essential and critical infrastructure with professional engineering support services that attract less discretionary spend, but still support additional ancillary revenues. We see a very different, lesser revenue flow ‘risky’ profile," wrote analyst Robin Speakman.

"This is not to say that pressures on UK public spending are having no effect on Babcock, it cannot be totally immune, but it is difficult to delay spending on that decommissioning nuclear reactor, in servicing that submarine, or leaving a gap in national electricity grid infrastructure."

He said Babcock undoubtedly has other issues to address, namely convincing investors of the strength of its long term profitable growth potential.

But the weakness in the shares was a long term buying opportunity, the analyst said investors should not have too long to wait as the company updates on its third quarter on or about 28 February.

Looking at the new financial year, he pointed out that Babcock shares were trading at 10.6 times 2018 forecast earnings on a free cash flow yield of circa 8.0% with debt-to-EBITDA falling to circa 1.4 times.

Speakman is not alone, with Morgan Stanley recently expressing its preference for Babcock among the government outsourcers, with the continuing pressure on growth due to increased competition and fewer large outsourcing opportunities seen as more of a worry for Capita.