The BAE Systems‘ share price has risen every year since Russia invaded Ukraine in 2022. It’s up 15% year to date too, but recently it’s been sliding lower.
In fact, it’s down 13.1% since mid-August, and it’s not alone. Rolls-Royce stock has pulled back 5% in recent days, while Babcock International (LSE:BAB) has slumped 17.1% inside a month. What’s going on?
Fiscal constraints
The common thread here, of course, is that BAE and Babcock are defence stocks, while Rolls-Royce has a dedicated defence unit. Recently, the Middle East conflict has flared back up, with Iran even attempting to attack Kuwait.
In turn, this has sent oil prices soaring and heightened concerns about inflation. None of this is good news for Rolls-Royce, which ideally wants a nice steady backdrop for its engines flying on commercial aircraft.
For defence stocks, the picture’s more nuanced. Yes, a protracted war in the Middle East favours higher defence spending, especially from oil-rich Gulf states that are already long-time customers of BAE.
But government bond yields are also rising, meaning debt-servicing costs are higher. Indeed, long-term borrowing costs for the UK government are now at a 28-year high!
Spending more on servicing the debt leaves less money for everything else, including defence. So there’s currently uncertainty.
Bruised Babcock
Back in July, UK defence stocks soared when John Healey was appointed Chancellor of the Exchequer. He had quit his previous role as defence secretary over a spending row, and his appointment was seen as bullish for the UK’s military budget.
It was viewed particularly favourably for Babcock, whose single biggest customer is the Ministry of Defence (MoD). But the FTSE 250 stock is now lower than when Healey was appointed — and down 33% since January!
I think this presents an interesting opportunity. Because even if defence spending isn’t going to ramp up as quickly as some hoped, the UK’s still committed to spend 3.5% of GDP on core defence by 2035. That’s tens of billions extra a year.
Moreover, Babcock specialises in areas that the government’s prioritising. For example, it provides engineering support and maintenance for the entirety of the Royal Navy’s nuclear submarine fleet. But the firm’s also active in the civil nuclear side.
Nuclear already makes up 40% of group revenue today, but clearly this is an industry set up for long-term growth, notably with small modular reactors (SMRs). Through a joint venture, Babcock won a contract to support Rolls-Royce’s SMRs in North Wales.
Whoever buys SMRs is going to need an owner’s engineer, a government-side person. No one’s ever done this before, so everyone needs engineering support on the buying side…That adds up to a 25-year growth story.
Babcock International CEO David Lockwood
Furthermore, Babcock has capabilities in cybersecurity and autonomous weapons technology. It also runs SKYNET, the MoD’s military satellite communications capability.
What about valuation?
I already own shares of BAE and Rolls-Royce, so I’m not looking to add Babcock to my portfolio as well. But I think the stock’s worth a close look today, as it’s now trading for less than 14 times next fiscal year’s forecast earnings.
That looks great value for an established defence company with strong long-term growth drivers in place.
Who knows? Babcock could prove to be a FTSE 100 bargain staring us in the face.
Should you invest £5,000 in Babcock International Group Plc right now?
When investing expert Mark Rogers and his team have a stock tip, it can pay to listen. After all, the flagship Twelfth Magpie Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets.
And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Babcock International Group Plc made the list?
Ben McPoland owns shares in BAE Systems and Rolls-Royce.
This story originally appeared on Motley Fool
