Babcock International PLC (LSE:BAB) shares climbed more than 4% on Monday, topping the FTSE 100, after RBC Capital Markets initiated coverage on the defence engineering group with an ‘outperform’ rating and a 1,200p price target.
In a bullish 40-page note, RBC argued Babcock is now "a significantly better-quality business" nearly five years into its turnaround but still trades at a steep discount to its European defence peers.
On a 12-month forward basis, the stock sits on just five times earnings, compared with 10 times for the broader sector.
The Canadian bank cited improved management execution, reduced contract risk and rising earnings quality as key drivers behind the call.
"Babcock's management is one of its key strengths," he wrote, noting three earnings upgrades in financial year 2025 and a recent increase in mid-term guidance.
Visibility, cash flow and optionality
The group now derives 74% of its revenue from defence contracts, up from 46% in 2019. Around 60% of group turnover is linked to the UK Ministry of Defence, a relationship that RBC believes provides high visibility.
"Revenue cover is circa 80% per annum," the broker notes, "which translates into high free cash flow conversion and returns on capital employed above 20%."
The upcoming renewal of Babcock’s largest contract, the Future Maritime Support Programme (due by March 2026), is seen as a potential catalyst.
RBC also flagged the replacement value of Babcock’s naval infrastructure, such as the Devonport and Rosyth dockyards, as likely in excess of the group’s market capitalisation.
RBC expects Babcock’s adjusted EBIT margin to improve from 7.5% in 2025 to 8.7% by 2028, with further upside possible if procurement reforms materialise or earnings from shipbuilding and international partnerships grow faster than forecast.
Capital deployment a new lever
Babcock’s £200mn share buyback, announced alongside its June results, was the first in its history and signals a shift from balance sheet repair to active capital deployment.
RBC estimates the group could have more than £900mn in firepower by 2028, thanks to strong cash generation and minimal leverage.
Management is seen as disciplined. "Babcock walked away from two M&A opportunities in 2025 as the business cases didn’t stack up," the broker notes.
Buybacks, rather than acquisitions, are more likely in the near term, with earnings per share accretion of 4 to 9% possible under base case assumptions.
Valuation case still strong
Despite the strong run this year, with shares up 97% year to date, RBC believes the valuation still looks appealing.
The bank values Babcock at 20 times 2026 earnings, slightly below the sector median, but sees scope for re-rating as margins improve and optionality from new contracts materialises.
A planned investor visit to the Rosyth shipyard on 4 September is highlighted as a possible inflexion point for the stock, particularly if management outlines a clearer strategy for export-led growth in naval manufacturing.
With better fundamentals, high recurring revenues and multiple growth levers in play, RBC concludes that the market is still underestimating Babcock’s recovery.
The shares were up 43p at 1,038p.