DBRS Assigns BBB (low) Rating to Babcock International, Trend Stable

DBRS has today assigned a rating of BBB (low) to the Senior Unsecured Debt of Babcock International Group (Babcock or the Company), and an Issuer Rating of BBB (low). The trends are Stable. Babcock is the leading engineering support services company in the United Kingdom, with the majority of its business involving long-term contracts with government customers.

Key factors that contribute to the assigned ratings for Babcock include: (1) The Company has historically focused on a limited number of end-markets where it has strong technical capabilities and specialized expertise, which has led to strong market positions. (2) Babcock is among the largest companies in the engineering support services sector. The Company’s scale provides economies and its significant backlog (roughly GBP12 billion) adds stability and visibility to earnings. (3) Babcock’s capital intensity is low, which contributes to consistent free cash flow generation and the ability to reduce debt. (4) The Company has proven its ability to successfully bid on contracts and minimize risk.

The rating also takes into account several challenges facing the Company, including: (1) Babcock has historically generated relatively low margins, mid to high single digit, in line with the engineering support services industry average. (2) The Company’s debt outstanding is largely short term in nature, and includes a GBP400 million bridge loan that will need to be refinanced shortly. DBRS expects that the Company will be able to accomplish this despite the difficulties facing Eurodollar banks today, but the associated liquidity risk remains until this is accomplished. (3) Babcock’s customers, which primarily include departments of the U.K. government, have significant countervailing power. (4) The acquisition of VT Group plc (VT) added to the amount of goodwill on the Company’s balance sheet. Given the lack of significant tangible fixed assets, limited collateral is available to support debt, and there is a risk of future goodwill write-downs. That said, Babcock owns a number of dockyard facilities which are not stated at open market value in the balance sheet. (5) The complex nature of some of the service contracts handled by the Company adds risk to its business profile.

DBRS notes that Babcock has established a solid track record of growing through acquisitions, with no material integration issues stemming from cultural factors. Babcock’s operating results have steadily improved over the past several years. While its key credit ratios over the 12 months to September 30, 2010, are aggressive for the assigned ratings, this is mainly due to the inclusion of debt related to the VT acquisition and less than one-quarter of VT operating results. DBRS expects Babcock’s financial metrics to gradually improve from a combination of organic and VT-related growth and free cash flow used for debt repayment.

Notes:
The rating on the Senior Unsecured Debt assumes that future debt issuances and bank lines will continue to rank pari passu.

The applicable methodology is Rating Engineering and Construction Companies, which can be found on our website under Methodologies.

The methodology supporting this rating starts with the public DBRS methodology for Engineering & Construction Companies, recognizing that the construction-related aspects do not apply to Babcock, which is an engineering support services company. For Babcock, we also place greater stress on two areas noted as secondary considerations in the public methodology, which are “the nature of contracts” and “diversification”. In addition, there are four areas that are not part of the public methodology which we would add as meaningful considerations, namely, technical skills, infrastructure facilities, reputation and technology.