Babcock International Group PLC (LON:BAB) has been upgraded to ‘equal weight’ from ‘underweight’ by analysts at Barclays, however, the bank said it is anticipating “weakness” in the UK defence market as growth in modernisation spending began to decelerate.
In a note on Friday, the bank said it saw “supply chain and production disruption” caused by the coronavirus pandemic in the second half of 2020, in addition to cost burdens from completing delayed work and an unwinding of working capital as government customers began to cease or slow advance payments supporting supply chain health during lockdowns.
READ: Babcock hit by aviation contract delays, oil and gas weakness
“Further out, we think defence valuations could be at risk on decelerating outlays/revenue growth in the US…most exposed as discretionary product demand is likely to be targeted ahead of longer cycle work and eventual budget pressure in core markets given unprecedented deficits resulting from [coronavirus] stimulus packages”, Barclays said.
As a result, the bank predicted that the resultant pressure on defence spending “may be more pronounced than during the [2008 financial crisis], particularly if we were to see a Democratic election outcome in the US”.
With this in mind, Barclays upgraded Babcock and cut its target price to 419p from 470p, saying the higher rating reflected “valuation and high exposure to defence-critical activities”.
However, the bank said BAE Systems PLC (LON:BA.) was its ‘top pick’ among the European aerospace and defence firms due to “[free cash flow] growth, long-cycle visibility, balance sheet optionality and the offsetting impact of US acquisitions against civil aerospace exposure” and retained their ‘overweight’ rating and 760p target price on the stock.
In mid-morning trading shares in Babcock rose 3.2% to 374.1p while BAE was up 1.1% at 498.3p.