In a world where world-class British engineering seems like a rarity, it’s refreshing to know that companies in this sector are still thriving. While the UK may no longer be the manufacturing powerhouse it once was, there are still some gems to invest in. The FTSE 100 boasts giants like Rolls-Royce and BAE Systems, while the FTSE 250 offers some interesting options to support British engineering, such as Babcock (LSE: BAB), a defense firm that has been making waves recently.
Defence Sector Growth
The current global political climate has put the defense sector in the spotlight. With countries spending more than ever to protect themselves, the defense industry is experiencing a significant upturn. The invasion of Ukraine was deemed a “historical turning point” by the German chancellor, highlighting the increased emphasis on defense budgets worldwide.
Back in 2015, only three NATO countries dedicated 2% of their GDP to defense. Fast forward to 2024, and that number has surged to 23, with many exceeding the 2% mark. Babcock has reaped the benefits of this surge in spending, with its shares soaring by 151% since hitting a low point in 2021.
Security Contracts and Opportunities
Poland, now ranking as the highest defense spender in NATO, has awarded Babcock with a significant contract involving the construction of three Arrowhead 140 frigates. These massive vessels, spanning 140m and requiring a crew of 100 each, are set to generate a substantial sum of $3.8 billion in revenue in the coming years. Inspired by the UK Royal Navy’s Type 31 frigates, this project holds the potential to attract additional orders from other countries.
In a promising development, Indonesia has already signed a contract similar to Poland’s, while rumors swirl about Poland potentially adding five more frigates to its fleet.
Challenges in the Supply Chain
While these opportunities are enticing, potential challenges lurk in the supply chain. Increases in supply costs due to inflation have posed obstacles. Babcock’s initial agreement with the UK Royal Navy for five frigates at £250 million each had to be revised due to rising costs, requesting an additional £50-£100 million for the entire project. This move led to a dispute resolution process with the Ministry of Defence, signaling potential hurdles related to energy and labor costs at Babcock’s Plymouth facility.
Despite these challenges, Babcock’s recent full-year trading update paints a promising picture. The company reported earnings of £311 million, surpassing analyst expectations of £293 million. Moreover, the order backlog surged by 8%, hinting at future earnings growth. The resurgence of a small dividend after a prolonged period without one indicates positive cash flows. Overall, Babcock shows strong potential as a stock worth keeping tabs on, making it a valuable addition to any watchlist.
