Can Babcock International Group's (LSE: BAB) growth continue and are the shares cheap?
Capital appreciation is surely the goal of many investors. One method of achieving that is to buy companies with steady earnings growth. If bought when the shares are cheap, two drivers could move the share price up:
- growth in earnings, and
- an upwards P/E re-rating.
Highly successful fund manager Peter Lynch classified steady growers as Stalwarts, which he typically traded for 20% to 50% share-price gains. But whether buying for gains like that or holding for the longer term, we need to know if reliable earnings growth can continue, and whether the shares are cheap.
Seeking durable growth
Not all companies achieve stable growth as you can see by the aggregate performance of those in London's premier FTSE 100 index (UKX), where the compound annual earnings-growth rate has been just 0.7% over the last five years:
|Year to June||2007||2008||2009||2010||2011||2012|
|FTSE 100 index||6608||5626||4249||4917||5946||5571|
|Aggregate earnings per share||537||503||427||397||527||557|
Consistent, growth in profits that is back by cash-flow is a promising characteristic in today's markets so, for this series, I'm examining firms with annual earnings growth between 4% and 20%.
One contender is Babcock International Group (LSE: BAB), which provides outsourcing services to government and private sector customers including working extensively with the UK's armed forces. This table summarises the company's recent financial record:
|Year to March||2008||2009||2010||2011||2012|
|Adjusted earnings per share||33.4p||41.9p||51.37p||52.5p||61.47p|
So, earnings have grown at an equivalent 16.5% compound annual growth rate putting Babcock in the Stalwart category.
Babcock is an engineering support services organisation employing over 25,000 people in sectors like defence, energy, telecommunications, transport and education. Around 36% of revenue comes from support services, 35% from marine and technology, 20% from defence and security and 9% from international operations.
With the release of its half-year results on 6th November, Babcock revealed good progress with a set of desirable growth figures and a reduction in debt. The order book is up and now stands at £12.5 billion, which, the company argues, provides "excellent visibility of future revenue streams." The director's said that the firm entered the second half with around 90% of the 2012/13 financial year's anticipated revenue contracted and over 50% for the 2013/14 financial year. There has also been growth in the bid pipeline and new opportunities coming into the tracking pipeline, they said.
If the recent upbeat results are any indicator, further earnings growth seems likely.
Babcock's earnings growth and value score
I analyse five indicators to determine whether earnings growth can continue and if the shares offer good value:
1. Growth: revenue, earnings and cash flow have all been growing steadily. 4/5
2. Level of debt: net gearing of around 67% with borrowings just over three times earnings. 3/5
3. Outlook and current trading: good recent trading and a positive outlook. 5/5
4. Enterprise value to free cash flow: a trailing 28 and above historical growth rates. 2/5
5. Price to earnings: trailing at around 16, in-line with historic earnings growth rate. 3/5
Overall, I score Babcock 17 out of 25, which encourages me to believe this stalwart can continue earnings growth that out-paces that of the wider FTSE 100. The shares seem fairly priced when compared to the FTSE's price to earnings ratio of around 11 and the firm's growth predictions.
A record of steady growth and falling debt is attractive when taken with the positive outlook. The scoring dips on the valuation indicators, demonstrating that investors have noticed such attributes. There doesn't appear to be a valuation anomaly here.
Right now, forecast earning growth is 6% for 2014, and the forward P/E ratio is 13.4 with the shares at 991p. Considering that and the other factors analysed in this article, I think that looks like the shares price in the expectation of further earnings growth, so I'm keeping Babcock on watch for now.
Babcock International Group is one of several steady-earnings-growing stalwarts on the London stock exchange, each with the potential to deliver significant capital appreciation when purchased at sensible prices.
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> Kevin does not own any shares mentioned in this article.