Image source: Getty Images
Babcock International Group (LSE:BAB), the FTSE 100 defence, aerospace and security company, has seen its share price soar by 156% since the start of November 2024.
It has some civilian customers but most of its business comes from the sale of military equipment as well as the provision of front-line support and training. The group’s involved in every one of the UK’s naval programmes comprising submarines, aircraft carriers and frigates.
On the up
Over the past four financial years, the group’s grown rapidly.
During the year ended 31 March 2025 (FY25), its underlying earnings per share was 50.3p. In FY22, it was 30.7p. This has been helped by a 1.7 percentage point improvement in its operating margin to 7.5%.
Similarly, its return on capital employed has increased from 17.4% to 37%.
The group’s also been able to improve its balance sheet and pay down some of its borrowings. Babcock’s ratio of net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) was 0.3 at the end of FY25 compared to 1.8 at 31 March 2022.
Some challenges
However, as a reminder of how difficult it is to deliver large-scale engineering projects, Babcock has reported nearly £200m of losses on its Type 31 frigate programme.
Another potential issue is that the group pays a tiny dividend with income investors likely to be disappointed with the stock’s current (3 November) yield of 0.5%. Rather than boost its payout further, the group’s part-way through a £200m share buyback progamme.
But above all else, it’s the sort of stock that challenges the conscience. Indeed, many ethical investors won’t touch the sector. But I believe it’s the duty of any government to protect its people. Defence spending is just that. It’s expenditure on people, weapons and facilities that should help deter others from a full-scale invasion.
A June survey by YouGov found that 49% of British people wanted an increase in such spending. Even so, the nature of its operations means there’s always going to be a smaller pool of investors willing to take a stake.
Not over yet
However, I remain confident that the group will continue to grow. In its most recent trading update — for the five months ended 31 August – Babcock listed a series of new contract wins and described its performance as “encouraging”. It also upgraded its medium-term guidance of an underlying operating profit margin of 9% compared to the 8% previously expected.
Importantly, despite the group’s recent share price rally, its price-to-earnings ratio is lower than that of both Rolls-Royce Holdings and BAE Systems, its two FTSE 100 peers. This suggests there could still be value in the stock.
Babcock’s operating in an industry that’s clearly benefitting from an increasingly uncertain world. NATO members have committed to spending 5% of GDP on “core defence requirements and defence and security-related spending” by 2035. Whether this happens or not remains to be seen. But the direction of travel is clear to me.
On this basis, I think it’s a stock that could be considered by long-term investors.
