Babcock warns on hit from Royal Navy frigate contract

Babcock International has warned it may take a hit of up to £100million on a contract to build frigates for the Royal Navy after costs surged since the project began in 2019.

The contract, named Type 31, marred an otherwise upbeat update from the British engineering group, which said profit for the year to the end of March would meet expectations and it expected to reinstate its dividend for investors next year.

Babcock said it was seeking to claw back the extra costs, resulting from ‘material macroeconomic changes’, from its key customer, the Ministry of Defence.

Without any recovery of costs, the contract, which is for five frigates at an average production cost of £250million per ship, would be loss-making, Babcock said today.

Babcock said it had been ‘unable to reach agreement with our customer as to who is responsible for the additional costs under the contract’.

It has started a resolution process that could result in an arbitration after talks with the MoD failed.

Today, Babcock warned a worst-case scenario would see it take a one-off provision of between £50million and £100million to be recognised in its 2023 results.

It has so far recognised £600million of revenue but no profit on the programme, which runs to 2028. The first ship, HMS Venturer, is expected to be completed in December this year.

However, Babcock said the ship design remained attractive and it was in active discussions with prospective export customers. 

The London-listed engineering group said cash flow for fiscal 2023 ending 31 March  was significantly ahead of expectations after strong operational performance and the conclusion of the disposal program. This included the receipt of around €100million of completion adjustments on the disposal of the European Aerial Emergency Services businesses.

The company’s net debt at 31 March was around £350million before operating leases.

Babcock shares fell today and were down 1.99 per cent or 5.80p to 286.20p this afternoon, having fallen around 11 per cent in the last 12 months. 

In November, Babcock upheld its annual guidance following a succession of contract wins and sales growth across all business divisions.

The defence contractor’s organic revenues grew by 5 per cent to £2.14billion in the six months ending September against the same period last year, driven by solid performances from its nuclear and aviation arms.

Both segments benefited from an acceleration of infrastructure programmes, with the former aided by submarine work at the Devonport Royal Dockyard in Plymouth and greater levels of civil nuclear activity

Britain’s inflation rate remains in double digits at 10.1 per cent after hitting a 41-year high of 11.1 per cent in October, with industrial companies suffering from rises in the price of steel and energy.

High inflation and the demands involved of replacing weapons and ammunition sent to Ukraine has put the UK’s defence budget under pressure. Back in March, Rishi Sunak pledged an extra £5billion for defence.