Babcock International Group PLC

LSE:BAB

Earnings Call Transcript 2019-Q3

[Operator]

Ladies and gentlemen, welcome to the Babcock International trading update call. My name is Hailey, and I will be the operator for your call this morning. [Operator Instructions]I will now hand you over to Chief Executive, Archibald Bethel. Please go ahead.

[Archibald Bethel, CEO & Executive Director]

Good morning, and welcome all on the call. As usual, I'm supported this morning by our Financial Director, Franco Martinelli, who will kind of help me answer your questions. We did issue a trading update this morning. And before going to the questions, I would like to highlight a few key performance updates. Firstly, trading performance this year. I mean, generally, across our key markets of defense, aviation and nuclear, we have performed in line with our half year guidance, and I'm happy to confirm that in terms of the fundamental important areas of underlying profit margins and earnings, net debt reduction, new order intake and order book evolution, the group is trading in line with or ahead of our guidance at the half year. However, we're not perfect. Revenue in a couple of areas has been a little bit softer than we had forecast, and we now expect underlying revenue for the year to be around GBP 5.2 billion with additional exits and disposals in the second half of the year, coupled with lower revenues in our Rail and South African businesses making up the majority of the difference. We've also added 2 additional exceptional costs since the half year. The first relates to GMP equalization between men and women in our pension schemes. And every company with a defined benefit pension scheme is likely to have such an additional charge this year. We assess the charge at GBP 30 million to be paid over the next 6 years. We've also incurred an additional one-off tax charge of GBP 10 million relating to the costs associated with the restructuring of our European Aviation businesses to ensure we remain compliant with the aviation regulations post-Brexit even in a no-deal scenario. Secondly, looking forward to next year. We are confirming, basically, what we said at the half year position, and I'm only going to add 1 new item of guidance. We highlighted that in mid-2019 and '20, it will be a transition year as we come to the end of 2 of our biggest long-term contracts: the building of the 2 aircraft carriers and the early handback of our Magnox nuclear decommissioning contract, as we have discussed on several occasions now. The step-down in revenue from these 2 contracts, coupled with the revenue previously coming from the exits and disposals of this year, creates a step-down in revenue of around GBP 400 million next year. The profit contributions from these, plus the normalization of the Holdfast JV profits, again, previously highlighted, steps-down the baseline profit by around GBP 40 million. And all of this has been previously signaled. We're also now highlighting an additional ongoing cost of GBP 10 million per annum related to the U.K. leaving the EU. The cost relates to the operation of the new structure, mentioned previously, that has been put in place to meet regulatory requirements in our European aerial emergency services businesses across Europe. We're still in the detailed planning process for next year, and we are currently assessing the level of growth we might expect to drive in our key markets from our strong order book and pipeline of opportunities. And we will, of course, provide further details on this at our results presentation in May. And thirdly, in operational highlights, I don't intend to go through the RNS note, but we are really busy in terms of delivering contracts and winning new orders, and I would like to highlight the performance across our contracts remains strong. And we are really pleased at the continuing growth of our International business, as shown in our list of new contract wins. In particular, I would point to important new business wins in Australia, Canada and France. Overall, new order intake has been strong, and our order book and near-term pipeline of opportunities remains at around GBP 32 billion level, and we have added GBP 1 billion of new opportunities for the pipeline since the end of last year, in addition to replacing the year contract wins. And finally, we are looking forward to holding a Capital Markets Day in June, shortly after we announce our full year results. And on the day, it is our intention to lay out in detail our strategy and performance targets for the next few years. So let's move on to questions.

[Operator]

[Operator Instructions] And the first question is from the line of Joe Brent of Liberum.

[Joe Brent, Head of Research and Equity Analyst]

If I can have three questions, please. The first question, you've told us in 2020 what some of the drags are. Could you give us some indication of what some of the positive drivers might be, just the big numbers, to help us get a bridge? Secondly, on the Brexit-related costs in aerial emergency, could you give us some indication of when those became apparent, and if they have become particularly necessary given the fact there's a possibility now of a hard Brexit? And thirdly and finally, could you give us some indication of the profit trajectory in Holdfast, particularly the move between '19 and '20?

[Archibald Bethel, CEO & Executive Director]

Okay, let me take the first two, and then I'll ask Franco to do the third. And on the first one, yes, looking forward to next year, the order pipeline is pretty strong across the group. In fact, probably, the pipeline is strong as we have seen it in recent times. So I mean, in the U.K., in the defense side, I think the main projects have all been pretty much kind of [ shelved ]. We'll be looking to renew our MSDF contract in later this year. We are involved in the bidding for the Type 31e frigates. We are involved in the bidding on the FSS joint support vehicles. We're currently bidding on the ASDOT air contract. And we have been involved in a number of other potential related bids, and this is on an ongoing basis, so that remains strong. In the Aviation side, again, across Europe, we're working on a number of larger opportunities in terms of both emergency aerial services and military, building on the back of our successes in France. We continue to win further orders in France, and we are working on other European contracts. And then, of course, in our kind of co-home markets of Canada and Australia, we've picked up significant contracts this year that will then play into next year for starting of delivery, particularly in Canada with the Manitoba contract for emergency air services. And again, we're sitting on a number of other bids in Canada. And I think the significance of Canada is that this first contract provides us with an Air Operator Certificate for Canada, which actually we should also be able to use in time to have a look at some of the United States market for emergency firefighting. So again, that's a significant move forward, and next year that contract comes alive. And in Australia, the winning of the 15-year support contract for their 2 largest ships, so it's their Queen Elizabeth Class equivalents, the 2 Canberra-Class LHDs. Again, I think, a good new win, business that wasn't there previously, which, again, kicks in the next couple of months. Then in the Norway, we spent the last year mobilizing the large air ambulance contract there. Again, that contract now starts to kick in operationally. So I think looking forward into next year, we are in a pretty strong position. In terms of Brexit costs, we've had to, like most other companies, look at impacts on us in terms of Brexit as the process has developed, and that's not been easy or straightforward in any way. The big issue that affected us is the fact that all our 400 aircraft that are operating every day across Europe are covered by air operating certificates, which are, at the moment, governed by a European agency called EASA, and of course, on the 1st of April that relationship changes, and we have to put in place a fairly complicated structure that allows us in the event of any outcome. And initially, we were pretty sure, like most people, that, that would be a fairly soft structure, which we'd manage to put in place fairly quickly. But over the last year or so, as the uncertainty has proceeded, we have been forced, both in terms of our own kind of views on this plus our government customers in Europe to give them the certainty that they needed, we've had to move to a much stronger, harder structure. So we basically had to make a complete restructuring of the European businesses that allow us to comply with the regulations under EASA. That has resulted in -- has cost us a bit there. There was a tax charge there this year of GBP 10 million, and we're assessing that the cost of operating this complex structure going forward, again, at around GBP 10 million. But again, by the time we get to the May results and we may have some clarity -- more clarity on Brexit by that stage, we'll be able to kind of say more about what we actually think that figure will definitely be. But we'll get -- we think it will be around the GBP 10 million. Do you want to take the Holdfast?

[Franco Martinelli, Group Finance Director & Executive Director]

Yes. Joe, it's Franco here. Yes, the Holdfast stepped down, which I highlighted was about GBP 15 million. We're not changing that number. This is not new news. It's just that's what we expect the number to step down. Just to remind you, it's a long-term contract for 30 years, and it came to a benchmarking at the end of 10. We were able to reassess the costs, and we've done that and it should step down to a normal profitability, which, as I say, is a GBP 15 million step-down for next year.

[Operator]

The next question is from the line of Allen Wells of Exane.

[Allen David Wells, Research Analyst]

Three for me as well, please. Firstly, just on the revenue guidance of GBP 5.2 billion. I mean, it seems like you stepped away from giving an organic growth number there. I just want to see what the GBP 5.2 billion implies from an organic number versus the previous guidance, if anything has changed there? Secondly, just -- sorry, if I missed this, but just have to understand, the ongoing cost in relation to the emergency services business of GBP 10 million, exactly what is the additional cost? Why is there an additional GBP 10 million per year? Is this people? Is this something else? I'm not exactly sure what that is. And maybe just as a follow-up there, and to what extent you can comment, obviously. What did it actually then do the MCS profitability, which, obviously, had already fallen quite a way since the time of the Avincis acquisition? And then maybe one, very final one. Obviously, there's been a bit of noise since November on the nuclear new build in the U.K. Maybe if you could just make a couple of comments on your position of your Nuclear business? And what's going on there with those new build delays?

[Archibald Bethel, CEO & Executive Director]

Okay. I'll let Franco think about the ongoing costs. So on that first one, the revenue. I mean, this close to it, we just thought it was sensible to tell you we think that would come out, nothing more so. We're into March next week, the last month of the year. So we're kind of pretty well signaling that it's round about the GBP 5.2 billion figure, down from the GBP 5.36 billion of last year, top line. If you take out the one-off kind of disposals and exits, I suspect next year we are roughly pretty flat, very slightly negative, but pretty flat in terms of that growth. You've got to carry that step down and Magnox step down in there. So that's where we are on that. I'll finish -- I'll take the nuclear new build. Yes, the nuclear new build projects, I mean, to be honest, in the ones -- the Wylfa roofer and Moorside contracts, we've got nothing in our pipeline or order books. Even if these had progressed on the timescale, they were still some years away from Babcock being involved in these. So there's no immediate impact on us. We continue to grow our business at Hinckley Point, where the construction of that contract is well underway, and we are, year-on-year, picking up more business. We are one of the 4-contractor alliance that's involved in that project. I think, in terms of the future new build, well, again, a lot of that will depend on government strategy for the overall energy mix. If they remain with the strategic aim of providing 20% of energy from nuclear power, then they will have to find a way of making some of these contracts, some of these new projects kind of work. But we'll have to wait and see what kind of happens there. Franco, do you want to say anything about the ongoing cost?

[Franco Martinelli, Group Finance Director & Executive Director]

Yes, just reemphasizing what Archie said earlier, the soft structure we had in place was a top-level structure. What we've had to put in place as we've engaged with the local authorities in each country, we have an AOC in each country in Europe, is to produce a sort of a 2-company structure per country, which has added significant costs and some interface costs in terms of VAT between the 2. So those are the 2 principal areas of where the GBP 10 million comes from. So that's what we've had because, as I said, we've had to go to 2 companies per country. In terms of MCS profitability, the emergency services business is doing really well. We'll get into Norway next year, we'll get into Manitoba next year, so this is all driving an improved position. The actual profitability of what is -- MCS doesn't exist anymore because we've merged it into the other countries, so I can't give you that number. I think that's the 4 questions.

[Allen David Wells, Research Analyst]

And maybe just a quick follow-up, just to make sure I'm completely clear. Your previous guidance was low single-digit organic growth. Archie's comments said flat to slightly negative, and the difference there is basically the comments you made around the outages in South Africa and slightly weaker activity in Rail, is that correct?

[Archibald Bethel, CEO & Executive Director]

Yes, that's the main things.

[Allen David Wells, Research Analyst]

That's the delta, okay.

[Archibald Bethel, CEO & Executive Director]

Plus the additional exits in the second half of the year.

[Operator]

The next question is from the line of Karl Green of Crédit Suisse.

[Karl Green, Research Analyst]

I've just got a couple of questions. Just on the Brexit impact for the EMS business. Can you just clarify there is going to be no legal requirements for different structures as regards the military activities? That's the first part of that question. And then secondly, just to check that those incremental GBP 10 million costs are going to be tax deductible. The second question is just back to the issue of the Rail and the Eskom delays. Have you got any kind of line of sight around the likely recovery or the trajectory of that recovery for those businesses, please?

[Archibald Bethel, CEO & Executive Director]

Okay, right. Thanks for that. I'll -- I mean, first one's easy, the military side in Brexit isn't impacted at all. So there's no impacts on our military business in Europe. I'll let Franco answer in terms of the second aspect of the GBP 10 million and is that tax deductible.

[Franco Martinelli, Group Finance Director & Executive Director]

Yes, the tax -- yes, it's clearly tax deductible. They're just normal operating costs, so tax deductible and probably at higher than the 18% across Europe.

[Archibald Bethel, CEO & Executive Director]

Okay. In terms of the rail and Eskom, they're different. I mean, the rail one is related to basing of the timing of the ending. We're ending contract period 5 now. And as we announced not so long ago, we've been successful in securing the Scottish region for the next 10 years as part of CP6 and CP7. It was always going to be difficult to exactly know how this transition would take place, but we've found that the step-down from CP5 was bigger in the last half -- the second half of the year than we had originally thought it would be. That probably means that next year the build-up on 6 and 7 will be quicker. So when we come and look at next year's numbers, we'll be looking to see if there's any kind of gain, upside, in that there. And in Eskom, well, Eskom has been difficult all year. If anyone sort of follows that in the news, they are the world's most chaotic customer. We generally, in South Africa, would be expecting to be doing 3 major power station outages a year. If we do 2, we're doing fine, we do really well. If we do 1, it's not a bad year. This year, we haven't had 1 major outage, so -- which has been a really, really disappointing. As a result, again, you'll be able to read in the newspapers and all that, there's brown-out outages all over Johannesburg at the moment, and I think that situation has to change at some point in time. So again, although it's always the -- one of the areas that we always kind of say about South Africa, it is always difficult to predict. And I would expect that next year there's likely to be some sort of catch-up to get the power stations back on to the performance level that's needed to commit to these outages. So -- but that's South Africa.

[Operator]

The next question is from the line of Robert Plant of Panmure Gordon.

[Robert John Plant, Research Analyst]

Given that you're flagging the underlying earnings are unchanged, but revenues stepped down, probably the margin expectation has gone up since H1. You talk about the cost reductions and the higher JV contribution. What exactly has changed since H1?

[Franco Martinelli, Group Finance Director & Executive Director]

Okay. Yes, I think the truth of the matter is that the revenue step-down is at very low margin, so the actual effect on profits is low. So what we're talking about is marginal increases, partly to do with mix. The cost cutting, we're always doing cost-cutting improvement programs and we're doing it every year, and we're doing it this year as well, so that helped as well. In terms of what's changed, I think it's -- we're seeing the benefits of that cost-cutting coming through against a minor reduction in profit from those low-margin revenues.

[Operator]

[Operator Instructions] The next question is from the line of Sash Tusa of Agency Partners.

[Sash Tusa, Research Analyst]

This may be a question that you'd like to talk about more at the Capital Markets Day, but there seemed to be some quite significant changes going on in the U.K. land systems market with the joint venture announce of Rheinmetall and BAE Systems, and I just wondered how you see that affecting the DSG business, and in particular, your ability to access some of the major upgrades, Challenger 2, and possibly, ultimately, the Warrior upgrades, if there's a much stronger prime contractor there than there was before.

[Archibald Bethel, CEO & Executive Director]

I think in terms of -- I mean, I think in terms of what we've got planned in terms of DSG, I'm not that sure that, that joint venture is likely to have any significant impact. We probably look at it as probably an opportunity for us to have another customer because we've got facilities that support some of these vehicles already. But I think the joint venture is initially going to be -- primarily focuses on the standard new vehicle, Boxer, and then we'll look and see. I mean, we were always going to be a sub-contractor in terms of the Challenger 2 upgrade, if it happens. And I think that still would probably be the case, with the new joint venture being the prime. I'm thinking -- I'm looking at it more as maybe an opportunity than a threat.

[Operator]

And this concludes our question-and-answer session. I would like to turn the conference back over to Archibald Bethel for any closing remarks.

[Archibald Bethel, CEO & Executive Director]

Okay. Well, thank you for joining us this morning. I'd like to just end by, again, kind of emphasizing or kind of a -- yes, emphasizing again that this year, in all of the key main important areas, we are pretty much on track for delivering the results that we had indicated. And I think importantly to us, maintenance in growth of margins, reduction of debt and strong cash flow are the main areas that we have been kind of focused on. And I think looking forward to next year, nothing really new there. And again, just one thing I'd like to add is Brexit, EU costs. And I think like most companies, we have really struggled to make -- push buttons and make -- I mean, the reality is that if all of a sudden next week or the week after, there was a deal done, then it would look like we've spent this money for kind of nothing. But we really had no choice to do that. We've got customers that we have to satisfy and we can't take any risk on that. So this kind of lateness in the day of the things emerging has meant that we've had to put in place a structure that works all the way down to a no deal. And although that's unfortunate, it's something that we had to do. But I think it doesn't change the underlying strength of that business. The European emergency services businesses have been growing steadily for the last 5 years. Their margins are amongst the highest that we have in the group, and it's a business that we've got big hopes for in the future. But thank you, again, for joining us this morning, and if there are any further questions later on, please feel free to contact us. Thank you.