Broker snap: Babcock mark down overdone

20th Oct 2010 13:24

With defence spending cuts not as bad as Panmure Gordon initially feared, its optimistic long term thesis in Babcock International remains intact.Shares in the engineering support services company dropped yesterday as the Strategic Defence Review was announced, but the broker said the reaction "looked overdone in our view".Earlier in the year there was talk of the UK defence budget being slashed by somewhere around the 20% mark, but the government announced a slimmer cut of 8% in real terms over the next four years.The broker thinks the delay on the Trident decision announced in the review will mean that maintenance of existing submarines will be more important, which should benefit Babcock.The announcement also pointed towards significant re-organisation in Defence Estates with the aim of driving £350m of savings - "an area where we believe Babcock has expertise and can deliver real value", added the broker.However, the broker said reductions of 40% to tanks and 35% in heavy armour could affect some of its contracts and depress volumes in the short term. "The MoD [Ministry of Defence] wants greater value from existing suppliers/contractors, which could create some margin pressure albeit this should not be a surprise."In over-estimating the spending review, the broker does not see significant negatives that would lead to material downgrades to its 2010 forecasts, which remain below consensus levels.The broker sees "in excess of 30% upside to our unchanged target price of 750p, we re-iterate our 'buy' recommendation ahead of first half results on 9 November".