Investment Column: Babcock looks good for the long term
Games Workshop; International Ferro Metals
Wednesday 26 January 2011
Our view: Buy
Share price: 579p (+8.5p)
Last year's fears for the defence sector seem to have dissipated somewhat. The Government's cuts to spending were not as brutal as expected, and it continues to buy British. This is good news for companies such as Babcock International, which put out a solid trading update yesterday.
The statement showed its financials were hitting targets, the order book was robust at about £12bn, and 2011 was looking strong with contracts worth £6bn in the pipeline. While the defence and security, and support services divisions performed in line with expectations, demand has boosted international operations, and marine and technology showed strength across the board.
The group said in its statement that it was involved in "positive dialogue" with the Ministry of Defence and with the Cabinet Office. The Comprehensive Spending Review and Strategic Defence and Security Review are also expected to lead to "significant outsourcing opportunities".
Babcock bought rival VT last year and said investors would be looking at how well it performed. So far, it seems the integration is on track, with management confident of hitting a run-rate of £11m by the end of March. The message yesterday was similar to that of its half-year results: key markets should see long-term growth and the pipeline and long-term programmes mean it has "excellent visibility" on its future revenues.
Babcock also exceeded expectations on paying down debt following the VT acquisition. According to analyst John Lawson at Investec, the stock is trading on a price of 10.8 times estimated full-year 2011 earnings, dropping to 9.4 times next year. It looks a solid buy.
Our view: Hold
Share price: 347.5p (+7.5p)
It has been a January to forget for Games Workshop, the maker of table-top war games. In the first week of this month, the company cited "difficult trading conditions" and warned that profits for the year to 29 May would be below market expectations.
Yesterday, the toy-maker blamed inexperienced managers in stores for leaving it "flat-footed", following a restructure of staffing levels to reduce costs. To address this problem, Games Workshop said there is now an emphasis on customer service training to deliver like-for-like sales growth in "all territories".
But the retail shortfall dragged down Games Workshop's pre-tax profits by 15 per cent to £6.7m for the six months to 28 November, compared with £7.9m the previous year. However, it is not all doom and gloom at the specialist that sells the popular Warhammer series. It has taken decisive action to trim its global cost base, such as closing its facility in Shanghai in the first half.
Its shares are also underpinned by a potential 7 per cent dividend yield and Games Workshop said its core business model "remains strong". However, we have concerns about a forward earnings multiple of more than 13 at the company, a premium to the retail sector.
Granted, Games Workshop's wholesale business and niche customer base provide it with some shelter from a further fall in consumer spending, but we are not convinced its battles are over yet, so hold.
International Ferro Metals
Our view: Buy
Share price: 20p (unchanged)
The ferrochrome market is picking up, with spot prices firming on signs of recovery in the stainless steel market. Ferrochrome is a key ingredient in the production of stainless steel, so an uptick there should underpin prices in coming months.
This backdrop bodes well for International Ferro Metals, which boasts an enviable leverage to ferrochrome prices. Moreover, the stock is cheap, trading on multiples of under four times forecast earnings for 2012, according to Numis. In terms of enterprise value to earnings before interest, tax, depreciation and amortisation it is on under three times.
That is the good news. The bad news is that IFM faces furnace problems. It has engaged specialist engineers to sort out the issues, which will lead to a six-week shutdown per furnace over the summer. This might lead to some caution as the market awaits confirmation of progress and, ordinarily, we would be inclined to err on the side of caution. But the thin valuation and the revival in the ferrochrome market makes this a buy, albeit a somewhat speculative one because of the furnace issues.
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