UK Markets close in 7 hrs 33 mins

I’d buy these 2 high-yielding FTSE 250 bargains before their share prices recover sharply

Harvey Jones
Businessman leading a chart upwards

Defence-focused engineering contractor Babcock International Group (LSE: BAB) is yet another Neil Woodford pick that has disappointed, falling by more than half over the last five years, although there have been signs of a recovery lately.

Time to step up

The share price is up 16% over the past three months but stalled today, after its interim results revealed a drop in underlying profit before tax from £245.5m to £202.5m, while statutory revenue fell from £2.25bn to £2.19bn.

First-half results were nonetheless in line with expectations, with underlying revenue flat at £2.46bn, after allowing for the impact of “step downs”, resulting from big projects like the aircraft carriers coming to an end.

Chief executive Archie Bethel said performance was good across most of the group, with its “strong” Marine division offsetting some weakness in Aviation. The £2.75bn FTSE 250 group has increased its order book to a record £18bn, due to significant recent wins, including building the Type 31 warship for the UK’s Royal Navy and providing training to London’s Metropolitan Police Service.

Foreign fields

Babcock continues to expand internationally, including new Aviation operations in Norway and Canada, and amphibious assault ships for the Australian Navy. Its pipeline of opportunities has increased to £16bn as a result of increased bidding activity across all its markets, taking the total to £34bn, its highest ever.

Babcock now expects underlying revenue of around £4.9bn and underlying operating profit of between £540m and £560m. Despite today’s underwhelming market reaction, I thought the Babcock share price looked like a buy even before I realised it was trading at just 7.3 times forecast earnings, with a price-to revenue ratio of just 0.6.

Even better, the forecast yield is 5%, with cover of 2.7. A return on capital employed of 20% looks pretty solid as well.

Babcock has been subject to a shorting attack by a mysterious group called Boatman Capital Research, and today’s results show growth is slow, but I still find it highly tempting at the current low valuation.

Direct action

Here’s another embattled FTSE 250 stock, Direct Line Insurance Group (LSE: DLG), its share price having fallen almost 20% over the last year.

Motor and home insurance are tough sectors these days, as comparison sites turn them into commodity products sold largely on price, while squeezing the recurring income insurers have traditionally generated from auto-renewing customers. Direct Line refuses to appear on comparison sites, which makes it heavily reliant on its brand name to drive business.

The £3.78bn group now trades at a bargain valuation of 9.9 times forward earnings, but be warned, City analysts calculate those earnings will fall 17% this year, and 3% next. That may be reflected in today’s low price, but falling revenues are always a concern.

Bouncing back

Direct Line still lifted its interim dividend by 2.9% in July, and the forecast yield is now a whopping 10.1%. It is only covered once by earnings, and may be cut next year, but that would still leave the stock fulfilling its traditional role of offering a generous level of income.

Both FTSE 250 companies have had a bumpy time and I cannot promise it will be smooth roads from here, but I also suspect both have been oversold. The trick is to buy them before they recover, rather than afterwards.

More reading

Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2019