Babcock rises as RBC initiates at Outperform on turnaround, capital strength

Investing.com -- RBC Capital Markets has initiated coverage of Babcock International (LON:BAB) with an Outperform rating and a price target of 1,200 pence, highlighting improved execution, high visibility from long-term contracts, and balance sheet strength that supports future capital allocation.

Babcock shares rose 3.5% in London trading as of 08:35 GMT. 

Analyst Ben Pfannes-Varrow said Babcock is “a significantly better-quality business 4.5 years into a turnaround, but its 5x PE (NTM) discount vs. the European defence sector fails to capture this.”

“Babcock’s U.K. Ministry of Defence (MOD) relationship, military operational asset engineering know-how and infrastructure ownership underpins high visibility,” he added.

Around 62% of sales are tied to the MOD, with a 95% correlation to the U.K. defence budget since 2015.

Management improvements have been central to the turnaround. Under CEO David Lockwood and CFO David Mellors, the group has reduced contract risk, improved earnings quality and cut leverage from 2.4x in fiscal year 2021 (FY21) to 0.3x in FY25.

Defence now accounts for 74% of the revenue mix, compared with 46% in 2019. “Beat and raise is the mantra, with 3 earnings upgrades in FY25 and a recently increased mid-term (3-5 year) guidance,” Pfannes-Varrow said.

The analyst sees upside beyond consensus estimates, with a mid-term EBIT margin target of at least 9%, up 150 basis points from FY25.

He projects about 3% higher adjusted EPS than consensus for FY26–28, but added that “pipeline opportunities could drive c.8-30% upside to FY28e adj. EPS, with further upside from potential procurement reform.”

Babcock’s capital allocation is also broadening. The company announced its first £200 million buyback this year and, with leverage trending towards zero, RBC estimates firepower of more than £900 million by FY28—equivalent to 19% of market capitalization.

This could support share repurchases, M&A, or organic investment, Pfannes-Varrow said. 

Despite shares rising more than 100% year-to-date, RBC emphasized that valuation remains attractive, as Babcock still trades at a “5x PE sector discount” to the European defence peer group.