Engineering services business Babcock (LSE: BAB) has been in the news recently for all the wrong reasons. It all started at the end of October when an anonymous research outlet, Boatman Capital, issued a report on the company, claiming that it has been “burying bad news about its performance,” and the group’s management is “not up to the job.“
Babcock responded to these allegations in a press release, refuting the report’s “many false and malicious statements.” The Ministry of Defence (MoD), one of the group’s largest customers, also stepped in to reassure investors, issuing a statement declaring: “We monitor the health of all of our strategic suppliers, including Babcock, and remain committed to working with them on a wide range of programmes.” Last year, Babcock completed contracts worth £1.7bn for the MoD.
Unfortunately, over the past two weeks, further cracks have started to emerge in Babcock’s facade.
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Further bad news?
At the end of last week, it came to light that the MoD has given the company until the end of the year to show that it can complete the £200m overhaul of the UK’s nuclear submarine programme on time. A few days later, rumours began to circulate that the enterprise will announce an exceptional charge of around £100m against its helicopter business, acquired in 2014 for £1.6bn, which isn’t living up to expectations.
Today, management has responded to this rumour telling investors that “Babcock is currently undertaking a programme to strengthen the Group by exiting a number of small, low-margin businesses, including the Appledore shipyard, and is reshaping its oil and gas business.” The Appledore shipyard, which has not had any new orders for some time, was a weak spot mentioned in the initial Boatman report. Management doesn’t expect these adjustments to be material.
Too cheap to pass up?
With speculation about the company’s health building, I think it’s no surprise that shares in Babcock have lost more than 30% of their value since June. And with the City expecting the company to produce earnings per share (EPS) of just under 85p for 2018, these declines have pushed the shares down to a forward P/E of just 6.9, which, at first glance, might appear too good to pass up for value investors. But I’m not so sure. It’s clear the business has some weak spots and, as of yet, we don’t know how deep the problems go. As we have seen with outsourcing companies Capita, Interserve, Serco, Carillion and G4S, small issues can quickly spiral out of control in this industry, and shareholders are usually the ones left holding the bag.
The bottom line
So overall, Boatman Capital’s report might be nothing more than hot air, but newsflow from the company since the report was released confirms that the business is struggling.
With this being the case, even though the stock looks cheap based on current analyst growth expectations, I’m not rushing to buy shares in Babcock today. Indeed, with so much uncertainty surrounding the business, I think it’s almost impossible to try and put a value on the underlying company. I’m happy to watch from the sidelines, for now.
