The Babcock International Group (LSE:BAB) share price was over 11% higher in early trading today (25 June), after the defence stock announced its preliminary results for the year ended 31 March (FY25).

Compared to FY24, these revealed a 10% increase in revenue to £4.83bn and a 52% rise in underlying operating profit to £363m. Underlying earnings per share surged 63% to 50.3p.

However, it must be pointed out that the FY24 numbers included the impact of a £90m provision for cost overruns on its Type 31 programme with the Royal Navy. The group started building its third ship (of five) during the year. Excluding this, the increase in operating profit would be just under 11%. Although still impressive, it does act as a reminder that some of the group’s contracts are operationally complex. And potentially expensive if things go wrong.

Strong cash generation during FY25 has helped strengthen its balance sheet with net debt continuing to fall. At 31 March, it stood at just 0.3 times EBITDA (earnings before interest, tax, depreciation and amortisation).

To further reward shareholders, the group’s also announced a 30% increase in its dividend. This takes the full-year payout to 6.5p. Although never an income stock, the yield’s a rather disappointing 0.6%.

But fans of share buybacks will be pleased to see the group announce a £200m programme to purchase its own shares. This is the first time it’s pursued such a strategy.

Looking further ahead

Yet it’s the positive outlook that appears to have driven the group’s share price higher. Over the medium term (not specified), Babcock’s expecting to grow revenue by a “mid single digit”, and achieve an underlying operating margin of “at least 9%”.

For FY26, it’s targeting a margin of 8%, a year earlier than previously advised. Over the past two years, it’s been 7.5% (FY25) and 5.4% (FY24).

Not surprisingly, investors liked what they saw and the group’s market cap has been pushed over £5bn for the first time.

Ironically, the results were released on the same day that NATO allies gather in The Hague. At the conference, they’re expected to confirm their commitment to spend at least 5% of GDP on defence by 2035. Although there’s a bit of creative accounting here — 1.5% of this figure can be spent on things like cyber security and intelligence services — it’s clear that Babcock’s operating in a growing market.

Potential risks

However, the shares are becoming increasingly expensive. After today’s rise, the company’s now valued at over eight times its book value. And its stock trades at around 23 times FY25 earnings.

If its impressive recent growth continues, I’m sure this lofty valuation can be maintained. But if there’s any sign that the company’s not performing in line with expectations, I fear there could be a sharp correction in its share price.

Also, I acknowledge that investing in the sector is controversial. Many ‘ethical’ investors don’t want anything to do with the industry. However, in my opinion, it’s the primary duty of a government to protect its people and even if there was weren’t any conflicts in the world, they would still spend money on defence equipment.

I believe Babcock’s delivered another strong set of results. Investors comfortable with the sector could consider adding the stock to their portfolios.