Babcock International Group PLC (BAB) Earnings Call Transcript & Summary

Good morning, and welcome to the Babcock FY '24 Results Update and Type 31 Trading Update. [Operator Instructions] I would like to remind all participants that this call is being recorded. I would now hand over to Babcock's CEO and CFO, David Lockwood and David Mellors. Thank you.

Good morning. Hello, and thank you for joining the call this morning. As you will have seen, today, we issued an update on our results and on the Type 31 contract. And yesterday, the Board finished its final review of the results and all the final program estimates. And we wanted to take the opportunity to give you as much early transparency as we could before we get to the full prelims next week. So we are obviously spending close period. So we will tell you as much as we can, recognize that we're in close period and not actually doing the full prelims. So kind of what do I think you should take? How do I think we're doing? If you go back to the Capital Markets Day, we talked about the platform we were building, the strong growth opportunities, the opportunities to expand margin, the naturally cash-generative nature of the business. And if you look at the underlying results, all of those have come through building strongly on last year's performance. I think that's all really positive. I think the other really big positive for me is when David and I started nearly 4 years ago, we talked about the, if you like, the real balance sheet, not just what's in the accounting balance sheet, but all the things off balance sheet, the window dressing, then the finance. The last one left really is pensions, sitting off the balance sheet. And David will talk about it more and it's right that he does because he's led the charge on this. But we have made really good progress with the pensions, both in reducing the off-balance sheet liability, but also in reducing the annual charge. And I think a bit like we've done with customers, changing the relationship we have with trustees so that we now have a shared vision of what good looks like for our pensioners and the schemes themselves. So I think that's really good news in terms of future cash flows and if you like, the holistic balance sheet. In terms of the actual balance sheet, the strong cash flow has taken debt down so that we're now at 0.8 on a calculation basis that you use for net debt. So that's also really strong. So when I was a growing chat, probably the most important boss in my career once said to me, "Never look at a business through your weakest program or you'll misunderstand it, but never ignore your weakest program." So we can't look at the whole business without looking at 31. So I'll remind you, we've said for 4 years, our destiny is set 50% in the contract we set, 30% in how we mobilize and 20% then in how we either reap the benefits or have to manage the problems. The truth of 31, as we've said repeatedly, is the terms are not terms that we would now take. The terms where we take or we've taken on board risk we can't easily manage or, in some cases, manage at all. We then try to mobilize during COVID and latent in that are a number of issues, which are only surfacing as we go into the deep production phases. So now we're in the 20% of actually really trying to make the best of what we've got. So in the year, operation, and again, I'll let David do the numbers as is tradition. In the year, we've effectively with some large external help deconstruct the program, got under every line of every cost item and then rebuild it, re-understood the learner curve and made sure that the gaps which have been occurring, we understand the program fully. So we've got into a really, I think, much greater understanding of what it takes. The downside of that is that we've identified costs driven by engineering overrun. And also last year, we talked about the inflationary cost on labor. Our contract protects us to CPI, but labor costs, particularly in Rosyth area, are significantly above CPI, and that was not anticipated last year. So 2 big things there. The upside is when we look at the program now and we look at the latter ships, the ones which drive the affordability of the product for export markets, whether we build it or someone else builds it, actually, our core estimate of what those ships cost doesn't really move that much. What's moved is the cost of getting there. So the price hasn't really changed that much, but the cost of getting to the price has undoubtedly gone up. There obviously still remains risk. We haven't integrated the combat system's. So we're not saying we're completely out of the word, but the range of outcomes has -- is definitely narrowed. So the other thing is, and I know you all know this, but to the extent we have improvement plans, you only bank improvements as they occur. Whereas when you can see a cost, you bank the entire cost. The day you see it from a P&L point of view, even though you pay it out over the next 5 years of the program. So accounting in that sense is quite asymmetric between risk and reward. So we haven't given up on and have found quite a few things that could take the program forward in a better way that are yet to be mature in of the bank. So with all of that -- actually and the only other thing I'd say is just again to put 31 in context, it's about 5% or 6% of our revenue and about 5% or 6% of our workforce. So although it's really important -- and while it's causing us pain, it's really important. Yes, we shouldn't judge the company by that program. David?

Okay. Thanks very much, David. Good morning, everyone. So these are the results that we will be announcing next week at the prelims. The audit is largely complete, and we don't expect any changes from the figures we have here. I'll start with the cash flow and balance sheet numbers as these are not impacted by the Type 31 charge, and then we'll come on to the P&L in a moment. So let's start with free cash flow. Free cash flow was GBP 160 million. That's significantly ahead of expectations with good working capital performance being enhanced by some early customer receipts. Within that GBP 160 million free cash flow is an accelerated GBP 35 million of pension contributions, which I'll come back to in a moment. So significantly stronger cash flow. This has helped us reduce net debt to GBP 435 million or GBP 211 million, excluding leases. And the gearing ratio, as David mentioned earlier, is down to 0.8. So significant balance sheet strengthening in the year. On the pensions point I mentioned, we have made significant progress in the year in reducing the overall deficit and derisking the outcome. So as many of you know, we have 3 large U.K. defined benefit schemes and the tale of smaller ones. And we've reached agreements with the trustees of 2 of the 3 large schemes in the last few months on long-term funding arrangements. And these plans give better visibility and predictability of the scheme for both pensioners, trustees and obviously, the company. And there are many details in all of this. But fundamentally, the material points are as a result of the GBP 35 million accelerated contribution that I mentioned before, 1 of these 3 schemes has now reached self-sufficiency. And therefore, we don't expect to make any further contributions to that scheme and we expect it will be able to manage its own way to buy in or buy out in years to come. The second scheme arrangement covers amongst other things, the closure to future accrual of the scheme, which is our last big scheme that was open as well as a long-term funding arrangement. So what does all of that mean? That means on an actuarial basis, the total aggregate deficit comes down from an estimated GBP 400 million last year to an estimated GBP 200 million at the year-end FY '24. And the annual cash contributions drop from what we said previously at GBP 65 million down to GBP 40 million. So a material reduction. So on to the income statement then. So revenue grew 11% organically, with particularly strong growth in Nuclear and Land sectors, a continuation of what you saw at the half year. So very strong in both of those sectors. Underlying operating profit was GBP 238 million. But as the statement shows, this included 2 things, a GBP 90 million charge on Type 31, which I'll come back to. And also profit on the sale of a property of GBP 17 million, all of which completed in the year, so cash in the bank, et cetera, but still it's a one-off. So if we look at the result, excluding those 2 items on a kind of go-forward basis, the underlying operating profit would be GBP 311 million for a margin of 7% and that comparator for FY '23 as we presented last year would be GBP 265 million or 6.6% margin. So progress on revenue, profit and margin underlying. And the profit growth was driven by 3 of the sectors, actually Nuclear, Land and Aviation sectors. We'll give you more detail on those at the preliminary results, but good progress in all 3 of those. So on to the Type 31 charge taken at the year-end. So we've rebuilt the forecast cost of the program, working with external consultants as well as with the new group functions of engineering, supply chain and project management, which we've told you about before and you met at the Capital Markets Day. This has been a detailed bottom-up rebuild of the forecast costs to go, and the GBP 90 million is the total impact over the life of the program, all of which we've recognized in FY '24, although the cash impact of that GBP 90 million will be incurred over the life of the contract. And the 2 main impacts or changes in the forecast going forward, that generate that GBP 90 million are the maturing of the design and the labor rates, as David said. We are also planning some future productivity improvements and potentially continuation of the contract, but they are not included in the accounting in FY '24, although we expect to generate some benefit over the life of the contract that we recognize as it comes rather than upfront. So that's the Type 31 charge and the recognition during the year. And just to round off the results, having reintroduced the dividend at the interims, we will be proposing a final dividend of 3.3p, giving a full year dividend of 5p, in line with our capital allocation policy. So that's the summary of the results for the year.

So now to wrap up, I think David and I have broadly said the same thing. So in tradition to tell them what you're going to say, tell them and then tell them what you told them. I think we don't take 31 lightly. It's very important that we get -- having narrowed the band about something, we absolutely nail the program. So we're not taking it lightly. But if you look at the results, actually, we've made significant progress, generated significant free cash despite 31. So we also need to keep it in context. If you look back at your Capital Markets Day presentation, then I think the really positive thing is that this other than 31 is very in line with everything we told you, which is consistency is a pretty important thing in our world. So that's really good. And to be honest, David and I are looking forward to seeing you next Friday when we can fill you in with all the color, but we can't tell you now. So with that, we will open the floor to questions bearing in mind, as I said at the beginning, we are in close period and therefore, we can't answer the kind of questions that we will be able to answer next Friday, which is not a way of discouraging questions, it's just managing your expectations. Next slide, being 26th of July, just to be clear.

[Operator Instructions] And your first question comes from the line of Samuel Burgess from Citi.

So I'll start with the obvious question, and that's what's your level of confidence here that this is the last charge you'll be taking on Type 31. And it's my understanding that the program will be significantly derisked after delivery of the first ship. Do we have any update on the likely timing of first float for Type 31?

Yes. So one of the interesting things, and we'll talk about it more on the 26th. One of the interesting things about having deconstruct the program and really, really got to understand it is -- one of the things we understand much better is the relative cost and risk of things like out-of-sequence work, but also the relative efficiency of doing work in the shared or work afloat. And what it really proves in a nutshell is you want to do as much work as possible in the shed. So really, you don't want to move both 1 out until you need to get both 3 in, ship 3 in. So part of the reprogramming is to deemphasize getting a float because actually it's much more efficient to be in the shed. And as you can imagine, in the shed, you've got -- you're surrounded by stuff within the floors, if you came, yes, you will have seen. If you've been and seen, you have seen the pictures. But all of your access points -- at the moment, you afloat your access points to reduce. It's not about stability. It's very stable. But your access points reduce, therefore, your ability to get stuff on and off the ship reduces. So one of the things we have done in the reprogramming is to deemphasize float off and emphasize in-sequence working.

Your next question comes from the line of Chloe Lemarie from Jefferies.

I actually have one on free cash flow performance. If you could help us understand the breakout between what was timing versus in your underlying beat, please?

Yes, sure. So this is all about working capital. You will remember that we've said previously that working capital, we've made huge progress on in recent years and there was some risk of reversal. And we telegraphed that, that could be over the next couple of years, a few tens of millions. That didn't happen during the year. So the risk is still there, but it didn't happen. So we managed that. So that was a few tens. And about, I would say, the other half of the increased performance was due to the early payment of customer debtors, which obviously takes it out of one period and into the other. So I'd rather have cash early, but you only get it once. So that is straight timing. Everything else, CapEx, tax, interest, all the other line items were pretty much as we expected them to be. And the only other moving part obviously is that the GBP 160 million included the GBP 35 million accelerated pension payments, as I said earlier.

And fair to assume that the early payment of debt is obviously mainly pulled forward from fiscal '25, right?

Yes. So -- exactly. So that by itself would just come out of FY '25. The other 2 moving parts for FY '25, obviously, the cash impact of the GBP 90 million charge is recognized over the remaining life. So you need to think about that. But also on the plus side, the pension payments going forward at GBP 25 million lower every year. So that will be a positive for FY '25. So you need to take all those 3 things into account. So would FY '25 be more H2 weighted? Likely. Does that mean FY '25 isn't achievable? No, it doesn't. So we should still be okay for FY '25 cash.

Your next question comes from the line of James Beard of Deutsche Bank.

Just one question going back to Type 31. Are you able to give us some color around what has -- what if anything has changed in the labor market in Rosyth over the last 12 months relative to when you were sort of last devising cost assumptions for Type 31?

I guess there were a couple of things I would pick out. David may have a couple of others. Three things. Firstly, demand from -- we expected demand from competing -- people who compete for that resource to plateau and it hasn't. Number one. Number two, the inflation profile that we have when we set this provision isn't the one that played out. And therefore, wage settlements generically were higher than CPI. And finally, the framework we thought we'd have for non-U.K. workers has taken longer to enact than we thought. And so therefore, it's -- in the end, it's a supply and demand thing. It's taken us longer to get the supply to where we need. And the demand in the region is higher what. But David has probably go anything to add?

No, I think that's it.

[Operator Instructions] Your next question comes from the line of Joe Brent of Liberum.

Three questions, if I may.

Yes. But one at a time, Joe. Remember, we're old.

Well, me, too. But okay, one at a time it is. Firstly, on the -- you talked about profit on disposal, could you tell us what the cash on disposal is and tell us that's not in the free cash flow guidance.

Yes. So GBP 20 million with a profit of GBP 17 million all received in years, so it is in the cash flow number.

It's in the free cash flow for equity number.

Yes.

Okay. Secondly, my sense is numbers are probably going up a little bit today. I'd be interested to hear your perspective on where numbers could be a bit higher.

I think that's a conversation for next Friday. That's not something we can comment on in close.

Okay. And finally, for now, on the pension, I think we originally expected GBP 65 million, an additional GBP 35 million. That's GBP 100 million in, which accounts presumably for half the reduction from GBP 400 million to GBP 200 million. Is that math right? And what's the other GBP 100 million?

So there's a number of things in the rest of the reduction. We've done a number of derisking things and obviously, there's investment performance as well. All of the detail we'll give you next week. But things like closure to future accrual, obviously, reduced the overall deficits. So that's probably one of the big ones. We've mentioned before that we do several liability management measures. That's probably the most material. There's investment performance, there's contribution. So they're probably the big 3. So the ones that -- sorry, can I just reiterate. The ones outside contributions, which are just in our gift, how those play out are driven by the relationship between the company and the trustees and targeting and having an agreed view of what's in the interest of the members of the scheme and being able to do those other things is a function of completely changing our relationship with the trustees, but that didn't -- that wasn't magic. That was 3 or 4 years of hard work.

[Operator Instructions] Your next question comes from the line of George Mcwhirter from Berenberg.

Two, please. Just firstly, on the labor cost issue. Are you seeing any similar cost pressures outside of Rosyth? Or are they specific to the area? That's the first one.

Okay. So well, thank you for separating them as well. The answer is -- there are 2 issues: one is, is there a cost pressure and the second is who pays. So the big issue on Type 31 is under the contract, we pay for everything above CPI. So it's not who has the cost pressure, it's who pays for the cost pressure. So that is the big area. It's probably one of the higher areas of cost pressure, but also it's the one where we pay. That's the combination of the 2.

Okay. And the second one is on the nuclear growth. Is this being driven by nuclear infrastructure spending? And if so, how do you expect this to trend in the future in FY '25?

Yes, sure. So we'll give you the numbers next Friday. But yes, that's 1 of the 3 things. We -- if you remember at the half year, we said there are 3 things in the nuclear sector all going forward. So there was infrastructure revenue, and it did increase. So that is a big one. The submarine support work was also increasing at the half year, and that continued all the way through the second half. And also the Civil Nuclear business grew again as we expected. So all 3 areas went forward, which obviously drove the extremely strong revenue performance in nuclear and the profitability. On the infrastructure, we'll give you more detail next week. It will be a sizable number next year. I'll give you more of a steer next week. It will largely be down to timing as to roughly how much it will be, but it will be a similar order of magnitude, might be a bit lower, but a similar order of magnitude.

There are no further questions on the conference line. Now I'll hand back to David Lockwood for closing remarks.

Well, thank you all for taking the time. I recognize that this kind of call is quite frustrating because you can't ask and we can't answer the meaty questions. But I'm looking forward to having given you 10 days to prepare those meaty questions til next Friday, so we can have a really enjoyable session when we meet up then. So we look forward to seeing you then. And with that, enjoy the rest of your day.