Babcock International PLC (LSE:BAB) is one of the defence companies most exposed to the UK market and set to benefit from the Prime Minister's pledge to increase defence spending to 2.5% of GDP by 2027, analysts at Berenberg said as they upgraded their recommendation on the shares.
This commitment from Kier Starmer was higher than the analysts had expected, and they have adjusted their forecasts to incorporate a 7% compound annual growth rate in the UK procurement budget over the next decade.
The maker of the Type 31 warships and a range of land vehicles makes 70% of revenue from the UK, according to the most recent data in 2023.
Therefore, the outlook in the company's largest market is "much improved" following the announced increase in the defence budget.
"Consensus mid-term revenue growth expectations are too low, in our view," Berenberg said.
They see near-term catalysts including progress on de-risking the pension deficit and the award of the extension to the Defence Support Group contract.
Babcock's valuation is "attractive", with the shares trading on 14.8 times 2025 forecast earnings and a 10% three-year compound annual growth rate in earnings per share.
The Berenberg target price was lifted to 885p, and the rating was upgraded to 'buy', having downgraded the shares to 'hold' last year to reflect caution regarding the Type 31 frigate programme for the Royal Navy.
But now the analysts said they are "more confident that the risk on this programme has been contained", with the company's management having suggested that there is equal risk of further small provisions as there are provision releases.
"This lower risk profile reduces an overhang for the stock, in our view."