Babcock eyes benefits from spending cuts

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The outsourcing of critical defence operations to the private sector is only just getting started, Babcock International predicted, after the services contractor brushed aside spending cuts to deliver stronger-than-expected full-year results.

Shares in the FTSE 100 company rose as much as 7.2 per cent to hit a fresh record as the company reported a £12bn order book and a lower debt pile, which had swelled when Babcock bought rival VT Group for £1.5bn last July.

Babcock – whose deputy chairman Lord Hesketh resigned in November after he attacked the UK’s defence policy – garners about half of its revenue from the Ministry of Defence.

Although the MoD’s budget is being squeezed by 8 per cent over the next four years, Peter Rogers, chief executive, reiterated his view that the group would benefit: “We are part of the solution to the issue they face,” he said.

He added that the integration of VT, which contributed £856m to a 50 per cent rise in total sales to £2.9bn, had given Babcock the scale to bid for contracts that it otherwise would have struggled to handle alone.

Babcock – whose operations range from training military engineers to maintaining nuclear submarines – said it lifted “underlying” revenue and operating profit by 5 per cent in the year to March 31.

The group, whose non-defence operations include managing the Metropolitan Police’s cars, said it expected further outsourcing of critical jobs such as the management of the British military’s 80,000-strong vehicle fleet.

A £20.7m exceptional charge relating to the VT acquisition weighed on pre-tax profit, which fell from £129.2m to £115.4m, although the group said it was on track to deliver £15m in annual synergy savings.

The board recommended a final dividend of 14.2p per share, bringing the total pay-out for the year to 19.4p, up 10 per cent. Diluted earnings per share were 31.17p (46.1p). The shares closed up 28½p at 680p.

FT Comment

Shares in Babcock underperformed the blue-chip index by 12 per cent in 2010 and not only because bears were unconvinced that outsourcing companies would ultimately benefit from spending cuts.

Although most analysts were sold on the operational logic of the VT tie-up, sceptics were concerned about the size of a deal that lifted Babcock’s net debt to £890m. The group allayed some of those concerns on Tuesday, disclosing net debt of £729m at the end of March, about 2.4 times earnings before interest, taxes, depreciation and amortisation.

After rallying a fifth since the turn of the year, the shares trade on 11 times prospective earnings per share of 60p, which still looks undemanding compared with the likes of Serco.

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