Investment Column: Take profits in Babcock International

McBride; Dunelm


Our view: Sell

Share price: 715.5p (+4p)

Worried about defence cuts? No problem. At least that's the message from Babcock International.

In fact, the group says that countries such as Britain and America, which are laden with vast amounts of public debt, are increasingly looking to drive efficiencies by outsourcing defence work to companies such as Babcock, which is perhaps best known for maintaining the Royal Navy's submarine fleet.

We've always been slightly sceptical about the outsourcing story. All too often its trotted out as a panacea when people, often in the public sector, need to save money. The results are not always happy.

All the same, Babcock's trading statement yesterday was an upbeat one. Its progress over the first quarter was described as good and consistent with expectations announced alongside the results in May. The group's markets were said to be "robust" with opportunities for growth overseas and even in the UK. The order book (£12bn at year-end) is strong, and the company continues to throw off cash while benefiting from synergies following the acquisition of rival VT. The latter's US defence operations are, however, set to be sold – no great surprise.

So all appears fine and dandy. The trouble is, the market has woken up to the story and even though the shares have eased over the past few days, they are still up by a quarter this year. We're very happy with our buy recommendation in January at 579p. But the question is, what now?

At current levels, the stock is valued at nearly 12 times full-year earnings, falling to 10.5 times next year. The group has historically traded at about 14 times, which suggests that there is room for a little growth. But times are tougher now. It's a tough call. However, on balance, in the short to medium term we don't see much to drive the stock forward. Take profits.

McBride

Our view: Sell

Share price: 131.75p (-8.25p)

The last time we looked at McBride, we decided to sell, reasoning that its stock was likely to be pressured by the combination of rising raw materials costs and the ongoing consumer squeeze, particularly in the UK.

Indeed, the maker of own-brand household cleaning and personal care goods flagged up the negative impact of these very factors at the time of its interim results. The following few months saw a spike in the share price, with investors driving it to well above 150p, making our call at just under 140p look somewhat hasty.

But then came another period of weakness, which, together with yesterday's decline, means that McBride is now trading at just under 132p. The question is whether now is the time to buy, and the answer, we believe, can be found it yesterday's trading statement.

There was nothing in the update to suggest that input prices had softened, nor was there much encouragement on the retail environment, which the group characterised as "weak". This is hardly surprising, giving activity on the commodity markets and increasing signs of turmoil on the high street. On the upside, the group did say that, when it came to raw material costs, its "initiatives to recover these increases are continuing, but where this is not possible in the current weak trading environment, we are exiting non-profitable business [sic]". It said it would provide a further update at the time of its full-year figures.

We look forward to that release, which may well prove to be a catalyst for gains. But until then, we think the backdrop remains far too uncertain.

Dunelm

Our view: Buy

Share price: 450.5p (+45p)

The retail environment, as we noted earlier, remains clouded; in fact, the cloud seems to be turning a shade darker every day, with news of company administrations or restructurings or another dip in the mood ofthe consumer.

But there are bright spots. Dunelm, the homewares retailer, cheered the markets yesterday by announcing an uptick in sales.

This is no mean feat, particularly in light of the turmoil elsewhere. Adding to the attraction is the fact that Dunelm boasts a strong balance sheet, ending its financial year with nearly £32m in cash.

We would just stop here and recommending buying into this highly cash-generative business that is bucking the gloom. But then there is the valuation, which, at under 14 times this year, hardly looks prohibitive. That figure falls to under 13 times on estimates for next year, underscoring the investment case, in our view.

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