Morningstar | Babcock Remains a Key Supplier to the UK Ministry of Defence
Babcock is one of the largest suppliers to the U.K. Ministry of Defence. Based on long-term agreements, the firm offers maintenance and retrofit of warships and nuclear-powered submarines to the Royal Navy and provides fleet management for the British Army. The U.K. promotes Babcock as a strategic support partner to the British Army and the Royal Navy, and the firm has ownership or operational control of key naval infrastructure. Control over the docks of Devonport, the only place in the U.K. where large ships can be taken out of the water, gives Babcock an unbeatable advantage, and is a key reason why we believe it possesses a moat.As a result of strong organic growth and investments in adjacent areas, Babcock’s divisional structure became complicated and suboptimal, in our view. In this respect, we welcomed management’s announcement that it would realign the business, starting fiscal 2018, in four key sectors where Babcock has built up expertise and strong commercial positions: marine, aviation, land, and nuclear.Babcock is one of the main beneficiaries of increases in the U.K.'s defence budget and the U.K. government's commitment to increased outsourcing to the private sector, as highlighted in the 2015 Strategic Defence and Security Review. While the prospects of a budget shortfall would restrict the Ministry of Defence’s ability to fund increases in spending on defence equipment, we believe potential cost-saving programmes will be directed towards non-mission-critical services, and thus will have limited impact on Babcock's support service revenue beyond 2019.With 65% of the Royal Navy’s budget skewed to equipment support, the temporary withdrawal of ships from service is a possibility for the U.K. government to save costs, which could negatively affect Babcock in the short term. However. the U.K. National Shipbuilding Strategy 2017 confirmed that the Royal Navy is prioritising the creation of a new lighter frigate. Given this emphasis, cuts to the Type 26 Frigate and the Type 31e programmes are unlikely in our view, which will spur Babcock’s long-term growth and support margins.Babcock International Group is a holding company. Through its subsidiaries, Co. operates in four sectors: Marine, which provides an array of marine and naval engineering services; Land, which provides fleet management and training for customer-owned defense, emergency services, global airport and commercial vehicle fleets, as well as engineering services and technical training for customers worldwide; Aviation, which delivers an array of engineering services to defense and civil customers; and Cavendish Nuclear, which delivers nuclear engineering on nuclear decommissioning programs and projects across the U.K., as well as nuclear engineering services in training and operation support.
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