Babcock International has revealed a significant 19% drop in its underlying operating profits to £293.3m for the year ending March, as the company grapples with the financial fallout of Brexit and the Covid-19 pandemic. The defence contractor's woes are exemplified by a substantial £140m charge related to its contract to construct five Type 31 frigates for the Royal Navy, which has become loss-making due to escalating expenses tied to macroeconomic shifts.
The company attributes this decline in profitability to the limited escalation clauses included in the 2019-frigate contract award. This lack of protection against market volatility, coupled with persistent labour shortages and increasing raw material costs within the UK, has resulted in significant increases in project expenses. Moreover, late-stage design modifications for the first two vessels have added to the costs, alongside rising estimated labour costs as the design matured.
Notwithstanding the challenges faced by the Type 31 contract, Babcock's nuclear and aviation divisions displayed stronger performances, with operating profits excluding the loss-making frigate programme increasing by 19% to £433m. Chief executive David Lockwood pointed to strong underlying growth and improved margins in the company's strategic and operational progress, despite the uncertainty of the geopolitical landscape.
The company has also modelled various scenarios demonstrating the contract's sensitivity to ongoing economic fluctuations. A 10% increase or decrease in estimated production hours could alter losses by £29m, while a six-month delay in the production schedule would add £15m to the contract's loss. Additionally, a 10% change in average labour rate could shift losses by £34m, illustrating the project's vulnerability to market and operational shifts.
Shares in Babcock International declined over 3% on Monday morning following the announcement, reflecting investor concerns over the company's profit figures and contract challenges. This comes at a time when defence contractors await the UK government's long-anticipated defence investment plan, with Babcock remaining optimistic about long-term demand despite some governments re-evaluating priorities due to fiscal constraints.