DBRS Confirms Babcock International Ratings at BBB, Stable

DBRS has today confirmed the Issuer Rating and Senior Unsecured Debt rating of Babcock International Group PLC (Babcock or the Company) at BBB, each with a Stable trend. The rating action reflects that the Company has performed as expected. The current rating continues to be supported by a relatively stable business risk profile and a strengthening financial profile, which are well within the current rating range. Moreover, Babcock is well positioned to benefit from the ongoing outsourcing trend with its strong market position, engineering and technical expertise and proven track record. DBRS expects the Company to continue to strengthen its financial profile and for the current rating to remain stable in the medium term.

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. Babcock’s strong engineering capabilities and specialized expertise have enabled it to build a wide range of products and a long-established customer base, particularly in the U.K. defence sector. The long-term nature of the contracts and the visibility of its project pipeline help provide a stable revenue platform, which further enhances the business risk profile. The Company has continued to execute its strategy to maintain its lead position in the United Kingdom and grow its business overseas. The Company’s business risk profile has little changed from a year ago. Babcock has a strong market position in its businesses supported by a customer focused culture and integrating engineering and technical expertise. Babcock’s proven track record on meeting customer targets has further helped solidify its leading position.

The Company is well positioned to benefit from an ongoing outsourcing trend by the U.K. government to control costs. Moreover, the trend of outsourcing non-core functions is also gaining momentum in the corporate sector as a means to control cost and improve efficiency, another positive development for the Company. Its ongoing success in winning contracts, both new bids and re-bids, supplemented by acquisitions, has led to a relatively steady growth in revenue despite the recession in calendar year 2009. The Company faces some business risks, but DBRS deems those risks are manageable. The Company still has a meaningful concentration risk despite making steady growth in its overseas business, particularly in North America, South Africa and Australia. Its reliance on the United Kingdom, which accounts for about 84% of revenue based on the last 12 months to September 30, 2013, is material. The Company is also acquisitive and is exposed to integration risk. Nevertheless, the size of the acquisitions has been modest with the exception of VT Group plc in 2010. Additionally, the Company’s proven track record in integrating acquired operations has further diminished its risk exposure. Finally, the dependence on a highly skilled labour force will continue to be an ongoing risk, although the Company has demonstrated its ability to retain personnel.

The Company’s financial profile is showing steady improvement, and all debt coverage ratios are well within the current rating range. Operating performance in F2013 (year ended March 31) and the first half of F2014 has been on an improving trend as expected, led by its largest division, the Marine and Technology division. In F2013, strong internal cash generation and proceeds from the sale of non-core operations have more than covered higher capital expenditures, acquisitions and an increase in dividends, allowing the Company to deleverage the balance sheet. However, in the first half of F2014, the Company reported a modest deficit in free cash despite still strong internal cash generation because of rising dividends and acquisitions. Although the gross debt leverage is elevated, strong cash flow from operations and operating profits have supported all debt coverage ratios well within the current rating range. Moreover, the Company has strong liquidity (cash on hand and unused credit facility totalling GBP 466 million as at September 30, 2013) and no meaningful maturity before September 2016. DBRS notes that the near-term outlook on the Company is positive. The growing trend in outsourcing is expected to continue because of the drive to control costs and improve efficiency at governments and corporations as well as the need to have skills to manage complex transformation programs. A stable backlog and a large bid pipeline also bode well for Babcock to sustain its improving trend. DBRS expects the Company’s financial profile to show steady improvement in the medium term. Furthermore, all debt coverage metrics have a reasonable cushion to absorb an unexpected deterioration in operating performance, supporting the stability of the current rating in the medium term. However, the Company’s gross leverage is high for the current rating and hence, a large debt-financed acquisition could place the current rating at risk. Nevertheless, the Company has a good track record in acquisitions, and DBRS expects the Company to remain judicious in funding acquisitions.

Notes:
All figures are in U.K. pounds sterling unless otherwise noted.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Companies in the Services Industry (July 2013), which can be found on our website under Methodologies.