Babcock International (LSE:BAB, Financial) (3.9%), the second largest supplier of defence services in the United Kingdom and leader in emergency services through aircraft in Western Europe, Canada and Australia, is a company with clear competitive advantages (unique assets, exchange costs and economies of scale) and scantly cyclical (with 80% of its contracts at long term), which was affected in 2020 by the obligatory stoppages imposed by the governments.
In emergencies, with governments asking their citizens not to leave their homes, the number of accidents fell and the use of salvage, rescue and health services dropped. Consequently, margins will shrink this year, because they have had to continue paying the helicopter leases. Fortunately, per contract they receive compensation for installed capacity and value will be destroyed. Also, in defence services, part of the military training was postponed and in the maintenance services for military assets, productivity has fallen. This will have an impact on the savings which Babcock traditionally obtains from the British Defence Ministry and, consequently, margins will also be reduced in this business this year.
Once again, the important thing here is to discern that they are not cyclical businesses, although as a result of the quarantine periods they may seem to be at first sight. This market is reacting in an exaggerated manner to temporary problems that clearly do not affect their business in the medium term: there will continue to be accidents and it will be necessary to continue maintaining the armed forces. Accordingly, while our valuation falls by 10%, Babcock listing has fallen by 50% this year, from already cheap levels. Currently, companies with businesses comparable to those of Babcock, which, in our opinion, are not expensive, are trading at multiples between two and three times higher. We consider that Babcock listing should more than triple in the coming years.
From Francisco Garcia Parames (Trades, Portfolio)' Cobas Asset Management's second-quarter 2020 shareholder letter.
