Babcock International has been boxing against two ghosts this year: first, the collapse of Carillion in January made investors sceptical about any company uttered in the same breath as the word “outsourcing”; and, second, since October there have been suggestions, circulated by the still-untraceable analysts at Boatman Capital, that its relationship with the Ministry of Defence is “terrible”.
While Babcock arguably has been slow to address both of these concerns, neither justifies a 33 per cent fall in the share price since June that makes the stock look cheap even by the standards of its unfashionable sector.
Babcock was founded in 1891 as a company that predominantly made boilers. It moved into defence during the course of the two world wars, changed its name from Babcock & Wilcox in 1979 and listed on the stock market three years later. In essence, it is an engineer, providing equipment, systems and training, much of it still in the defence industry, in Britain and overseas. It operates four main divisions: marine, land, aviation and Cavendish Nuclear, which among other projects is involved in decommissioning the Magnox reactors and developing the Hinkley Point C power station in Somerset.
Let’s not waste time with the first ghost. Carillion really is a phantom. The government contractor went under because of its construction business and non-existent margins, while Babcock is a much more sophisticated provider of services, from operating air ambulances to providing critical equipment and systems for the navy. Its margins are an impressive 10.9 per cent and are improving.
The concern about the MoD is less of an apparition. Babcock’s work for the department accounted for about 40 per cent of group revenues of more than £2.25 billion during the first half. Even if we ignore the reassurances on both sides that relations are warm, the £650 million of MoD work Babcock won in the first half provides comfort. Neither side has any interest in allowing the co-operation to sour.
Babcock exorcised another worry last week, assuming for accounting purposes that it will not pick up any work from the Nuclear Decommissioning Authority when — for reasons entirely unrelated to the engineer — it takes the contract to decommission Magnox back in-house next year. This means that any wins it does pick up from the £3.5 billion project will be an unpresumed benefit.
The shares, off 4¼p at 574p yesterday, have been in steady decline for almost four years but there are reasons to believe that a recovery should be on the way, not least with debts under control and an international business growing. Trading at about 6.8 times forecast earnings for a yield of more than 5 per cent, the shares look appealing.
ADVICE Buy
WHY Concerns about the MoD relationship seem overblown, debts are falling and overseas sales are on the up
Fidelity China Special Situations
It would be churlish to judge the peformance of the Fidelity China Special Situations trust over only six months. Using a vehicle like this to gain exposure to growth in the world’s second largest economy is a long-term game and not for the impatient.
While it is true that the trust’s net asset value per share fell by 9.1 per cent in the six months to the end of September, over the past three years it has returned 79.4 per cent. Over the short run, it lagged the MSCI China Index, which lost 4 per cent over the most recent period; but over the longer term it did better than its benchmark’s gain of 70.7 per cent.
The trust was set up in 2010 and initially was run by Anthony Bolton, the famed stockpicker. Since he stepped aside in 2014, Dale Nicholls has been at the helm. As well as investing in locally listed companies, the trust buys China-focused businesses listed on international markets and has four unlisted investments. The main reason for the performance over the six months was falls in the value of the trust’s two biggest holdings, Alibaba and Tencent Holdings, the ecommerce businesses, but there feels little at either to fret about in the long term. Alibaba, still growing at an underlying 40 per cent, is pausing for breath rather than running out of it; Tencent suffered short-term delays receiving approval for important new mobile games, but is still the market leader.
At the core of the case, though, is China, whose economy has been dampened by a trade tariff spat with the United States and a slowdown in consumption, but is still growing at more than 6 per cent a year. The trust’s shares, up 1¼p to 193½p yesterday, are cheap, at less than four times earnings and, with a yield of 1.8 per cent, they are among the best ways to get access to it.
ADVICE Hold
WHY China’s long-term growth potential still looks strong
Petro Matad
When this column recommended that investors steer clear of Petro Matad shares at the beginning of October, they stood at 6½p. Last night shares in the Mongolian oil explorer closed at 2¾p, a precipitous slide of more than 47 per cent on the day after potentially its most exciting prospect was found to be dry.
The end of the line for Wild Horse 1, which could have yielded 480 million barrels, came after similarly disappointing test results earlier in the year at another “wildcat” prospect, Snow Leopard 1, with a possible 90 million barrels (although there was evidence of oil residues here).
Petro Matad is a Mongolian-focused oil explorer that has the rights to drill for the black stuff in two regions covering more than 60,000 sq km in the country. It listed on Aim in 2008 and has yet to discover or produce any oil.
To its credit, Petro Matad is pressing on. It has more than enough cash to cover the costs of drilling at the four wells it plans to explore next year. The other opportunities hold far lower potential reserves, but finds are more likely as they are in areas where oil has been found before. One site, Fox, could contain up to 200 million barrels. With Petro Matad’s big-win prospect now gone, there is even less of a case for buying in.
ADVICE Avoid
WHY The risks of failure outweigh the chances of a big find