(Alliance News) - Babcock International Group PLC reported beats across the board, but analysts said a surprise new charge for its Type 31 frigate contract may spark concerns of more costs to come.

Jefferies analyst David Farrell said the emergence of "significant" charges on the Type 31 contract, "unfortunately, overshadows what was another year of meaningful progress."

The London-based aerospace, defence and nuclear engineering services company said revenue rose 9.1% to GBP5.27 billion in the financial year ending March 31 from GBP4.83 billion a year earlier, or by 10% at constant currency.

Babcock said this reflected "strong underlying operational and financial performance" and "continued momentum and particularly strong performances in Nuclear and Aviation."

But underlying operating profit fell 19% to GBP293 million from GBP363 million and underlying basic earnings per share declined 21% to 39.6p from 50.3p, reflecting a GBP140 million non-recurring charge related to its Type 31 frigate contract.

Shares in Babcock International were 0.1% higher at 1,007.50 pence each in London on Wednesday.

Farrell explained the latest charge brings the total on the programme to GBP330 million, following those announced in financial 2023 and financial 2024.

"Market concerns about the execution of this project had begun to ease over the past two years as solid project progress was announced, meaning that while the risk of further charges was not completely ignored on this legacy contract, the scale of those announced this morning will likely be larger than contemplated," he said.

Excluding the charge, underlying operating profit increased 19% to GBP433 million, 5% ahead of consensus, operating margin improved to 8.2% from 7.5% and underlying basic EPS climbed to 60.5p from 50.3p.

The FTSE 100-listing said underlying free cash flow grew to GBP262 million from GBP153 million, 22% ahead of consensus, and net debt narrowed to GBP329 million from GBP373 million.

Babcock put consensus for full-year revenue at GBP5.11 billion, underlying operating profit of GBP411 million and free cash flow of GBP215 million.

Babcock said the GBP140 million charge reflects revised costs to complete delivery of the Type 31 design and build contract, which is fully recognised in financial 2026, with the cash costs incurred over the remainder of the programme.

Babcock said it has experienced "higher than expected levels of rework as a result of changes to the design and the long-term impacts of out-of-sequence build activity earlier in the programme."

"Whilst the number of such rework events is not entirely unexpected, the work is being performed in the later stages of completion and therefore is more complex and more costly," it added.

Babcock estimates GBP100 million of the GBP140 million will be recognised as a revenue reversal in financial 2026 with the balance increasing the contract loss provision.

Farrall at Jefferies said: "Given the build's late stage, though, these issues are more complex and therefore more costly to rectify. The activity will also impact assumed productivity improvements."

"It may take some time for the market to digest the charges on the group's last remaining legacy project, but it is important not to lose sight of the positive trajectory," Farrell added.

He stressed that excluding Type 31, Babcock delivered ahead of expectations "across the board".

At constant currency, Nuclear revenue increased 14%, driven by strong growth in the Cavendish Nuclear business and higher submarine support activity, more than offsetting the expected decline in Major Infrastructure Programme revenue.

Marine revenue grew 8%, before a GBP100 million revenue reversal as a result of the Type 31 charge.

Land revenue returned to growth in the second half of the financial year, but declined 3% overall, as growth in defence was offset by weaker civil volumes in Rail and South Africa.

Aviation revenue climbed 34% due to the ramp up of the Mentor 2 programme in France and the British Columbia helicopter emergency services contract in Canada, and increased scope in UK military support contracts.

JPMorgan analyst David Perry said the notable earnings beat came in the Land division, with the frigate charge the "only negative".

"This is the third charge on the programme and we believe it will be the last one, although this is not guaranteed," JPMorgan added.

While RBC Capital Markets analyst Ben Pfannes-Varrow called it a "bittersweet" trading update with "beats across the board", excluding the Type31 charge.

"We believe the existing consensus view was that existing Type31 provisions were cautious, hence this will come as a surprise. Comfort will need to be provided that further costs are not required," he added.

In addition, Babcock announced a new GBP200 million share buyback programme after completing a previous GBP200 million buyback in April.

Expectations for financial 2027 are unchanged, supported by around 70% of expected revenue already under contract.

Citigroup analyst Charles Armitage said the results contained a "two-way" pull with the underlying profit beat offset by the frigate charge.

"We believe the market felt the Type 31 problems were behind the company, so the charge is likely a surprise," he added.

"We think the subsequent share price movement will likely be determined by whether the company is convincing that the charge is truly one-off," Armitage said.

Following the update, JPMorgan raised 2027 to 2030 EPS forecasts by 3% to 4% per annum, which it said put it 8%/10%/10%/10% ahead of Bloomberg median consensus.

JPM noted Babcock shares have fallen 33%, compared to a 21% average decline for the European Defence stocks it covers. Reflecting the de-rating of the broader sector, the broker lowered its December 2027 share price target to 1,500 pence from 1,700p but notes this still leaves potential upside of around 50% over the next 19 months.

By Jeremy Cutler, Alliance News reporter

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