August’s V-shaped wobble in the stock market has left some FTSE 250 stocks languishing when I reckon they ‘should’ be motoring upwards.
One example is defence-themed company Babcock International (LSE: BAB). The shares haven’t made much progress despite the release of what looked like a fine set of results at the end of July.
If general market conditions had been better, it’s possible the stock might have risen more in August. But the fact it hasn’t may be an opportunity for investors to research and consider the business now.
The company reported “strong” progress for the 12 months to 31 March 2024. Operating profit and free cash flow were both much higher than the prior year. Meanwhile, underlying basic earnings per share shot up by almost 75%.
Chief executive David Lockwood said the firm made good strategic progress during the year and cash flow was “ahead of expectations“.
Trading well
That’s what investors like to hear: a business that’s outperforming its directors’ own assumptions.
However, it’s easy to become over-cautious and angst-filled, leading to fear that such strong trading can’t possibly continue!
Of course, it may not. But equally, it could. Reversion to the mean isn’t always an instantaneous effect! The whole sector looks robust right now and that current is likely to be helping Babcock along.
Lockwood said the business is “well positioned” to benefit from the “the sustained uplift” in global defence budgets. Many countries need to re-equip and modernise their militaries and that situation opens up ongoing opportunities for the firm.
Babcock provides services and products in the defence, aerospace and security sectors. Lockwood reckons the firm combines engineering know-how, customer intimacy and operational asset knowledge. All that helps to drive collaborative relationships and product development capability.
It’s a set-up that’s “increasingly attractive” to customers, Lockwood said, and the directors are confident about meeting the firm’s medium-term targets.
Strong earnings forecast ahead
City analysts expect a bumper year for normalised earnings in the current trading year to March 2025 — think an increase of just over 50%. There’s also likely to be a double-digit percentage advance the following year.
However, one of the risks facing a business like Babcock is that it may mess up on one or more of its fixed-price contracts. If the original cost estimates prove to be incorrect, profit margins can disappear and the company may miss its earnings expectations.
On top of that, many of the firm’s large customers are national governments. So a change in policy in the future may deplete Babcock’s order book.
Nevertheless, with the share price near 530p, the forward-looking price-to-earnings multiple for next year is just below 11.
I don’t believe that valuation looks excessive, so would be keen to dig in with further research now with a view to considering the stock for inclusion in a diversified portfolio.
