Babcock International PLC has announced a significant £90 million loss on its Type 31 warship contract, impacting its financial results for the fiscal year 2024, according to a trading update.
Despite this setback, the defence contractor reported stronger-than-expected cashflow and a 34% increase in underlying operating profit to approximately £238 million for the year ending March 2024.
The Type 31 contract, signed in 2019, involves the construction of five ships and represents the last major legacy onerous contract managed by Babcock. During the fiscal year, Babcock made progress on the programme, with the superstructure of the first ship nearing completion and significant advancements on the second ship.
The company also settled a Dispute Resolution Process with the customer, enabling a restructuring of the programme to drive efficiency and protect the in-service date.
According to the trading update, “The outturn over the lifetime of the contract has deteriorated by £90 million, which has been fully recognised in FY24. The cash impact of this loss is expected to be realised over the remainder of the contract.” The update further explained that “the programme has been restructured following a detailed operational review to protect the in-service date.”
The overall estimated programme costs have increased due to the maturing of the design and rising labour costs. The cost increases, exacerbated by labour market conditions in Rosyth, led to the £90 million deterioration in the total contract outturn. Babcock noted, “The increase in the cost of labour in the market available to Rosyth is forecast to be higher than CPI, the indexation within the Type 31 contract.”
Babcock initiated an operational improvement programme during the year, supported by external consultants, to address cost drivers and financial modelling. This programme, led by a new management team, aims to restructure the contract and enhance productivity. The mature design of the Type 31 has facilitated these efforts, although it has also increased the volume of work required.
“During the year we initiated an operational improvement programme to challenge all aspects of the contract, including a significant focus on cost drivers and financial modelling,” the update stated. “Our operational improvement programme is facilitated by the fact that the design is now more mature. Although this has increased the volume of work, the design maturity has allowed us to target improvements in productivity and ongoing support costs as well as benefitting prospective export sales of our Arrowhead 140 design.”
The Audit Committee has reviewed plans to deliver additional programme benefits from productivity improvements and the continuation of the Type 31 contract. However, some expected benefits have not been accounted for in the loss due to the high evidential bar required to recognise future gains.
In addition to the £90 million loss on the Type 31 contract, the company reported a £17 million profit from the disposal of a property. Excluding these items, Babcock’s underlying operating profit for FY24 was £311 million, compared to £265 million in FY23, which included a £100 million loss on the Type 31 contract and a one-off accounting credit of £12 million.
“The Audit Committee has reviewed the programme team’s plans to deliver additional programme benefits from improvements in productivity and further work relating to the continuation of the T31 contract,” the update mentioned. “Some of these benefits have not been taken into account in the loss given the evidential bar required to recognise future benefits, although we do expect the benefits to be delivered over the course of the programme.”
The restructuring and improvement initiatives are expected to mitigate future risks and potentially benefit the prospective export sales of Babcock’s Arrowhead 140 design. The external audit of Babcock’s financial results is substantially complete, with the company planning to announce its FY24 preliminary results on 26 July 2024.
Overall, Babcock International remains committed to delivering on the Type 31 contract and enhancing its operational efficiency, despite the financial challenges faced in the current fiscal year.