Defense in Depth: Why Babcock International's Strategic Positioning is Fueling Long-Term Growth in a Tense World

The global defense sector is entering an era of sustained growth, driven by escalating geopolitical tensions and renewed fiscal commitments from governments worldwide. Nowhere is this clearer than in the UK, where the government's pledge to raise defense spending to 5% of GDP by 2035 has positioned companies like Babcock International (LON:BAB) to capitalize on structural tailwinds. With robust financial results, a transformative share buyback program, and strategic partnerships unlocking export opportunities, Babcock stands at the forefront of a defense renaissance. Here's why investors should take note.

A New Era for Defense: Catalysts in Motion

The UK's defense budget expansion is a linchpin of Babcock's growth story. The government's commitment to 5% GDP allocation by 2035—up from roughly 2% in recent years—ensures sustained demand for critical infrastructure, from nuclear submarines to advanced aircraft systems. This aligns with NATO's broader push for increased defense spending, with member states collectively pledging to spend 2% of GDP on defense by 2024. For Babcock, which derives 85% of its revenue from UK defense contracts, this is a multiyear windfall.

Babcock's recent results underscore this opportunity. In its fiscal year ending March 2025, the company reported 11% organic revenue growth to £4.83 billion, with underlying operating profit surging 53% to £363 million (excluding one-off items). Its contract backlog has swelled to £10.4 billion, fueled by wins such as the £1 billion DSG Refresh contract (Land division) and the French Mentor 2 deal (Aviation). These contracts lock in visibility for years, providing a stable base for future earnings.

Margin Expansion and Capital Allocation Signal Strength

Babcock's financial discipline is equally compelling. The company has targeted an underlying operating margin of 9% by 2026, up from 7.5% in FY2025. This improvement is driven by operational efficiencies in its Nuclear and Marine divisions, which delivered 19% and 4% revenue growth, respectively, in Q2 2025. The Land division also turned a corner, achieving a 7.7% margin—a significant rebound after years of restructuring.

Crucially, Babcock is returning cash to shareholders. The £200 million share buyback program, its first ever, and a 30% dividend hike reflect confidence in its balance sheet. Gearing has dropped to 0.3x, one of the lowest in the sector, thanks to strong cash flow (£153 million in FY2025) and strategic capital management. The buyback also underscores a belief that BAB's shares are undervalued: at 1,093p, the stock trades at just 8.5x FY2026E EPS, below its long-term average.

Strategic Partnerships and Long-Term Growth Drivers

Beyond the UK, Babcock is leveraging partnerships to expand its global footprint. Alliances with firms like Saab, HII, and Safran are unlocking export opportunities in markets such as France, the Middle East, and Australia. For instance, the Mentor 2 contract in France highlights Babcock's ability to secure high-margin work abroad.

The company's nuclear expertise is another key differentiator. With the UK's Dreadnought and Orkus submarine programs requiring decades of maintenance and upgrades, Babcock's role as a critical partner to the Royal Navy is irreplaceable. Similarly, its work on nuclear power plants positions it to benefit from global energy security priorities.

Investment Thesis: Buy the Dip, Hold for the Long Game

For investors, the entry point is attractive. Despite a 125% YTD surge, BAB remains undervalued relative to its peers and growth trajectory. The buyback program and dividend hikes further reduce downside risk, while the £10.4 billion backlog provides a buffer against near-term macro headwinds.

Risks and Considerations

No investment is without risks. Babcock's exposure to UK government contracts creates reliance on political stability and budget execution. Additionally, delays in major projects—such as the Mentor 2—could impact quarterly results, as seen in the Aviation division's 4% Q2 revenue dip. However, these are manageable given the company's diversified portfolio and long-term contract visibility.

Conclusion: A Security Play for Uncertain Times

In an era of heightened geopolitical risk, defense spending is a rare “recession-proof” sector. Babcock International's strategic positioning—bolstered by robust financials, a growing order book, and global partnerships—makes it a standout play on this theme. With margins set to expand and shareholder returns prioritized, BAB is a buy for investors seeking resilience and growth in turbulent times.

Hold for the long term, and let the defense boom do the heavy lifting.