Northrop Grumman Corporation (NOC) is one of the world’s leading aerospace & defense contractors, with broad expertise in providing a wide range of products and services to the United States forces and its allies.
Northrop Grumman’s extensive scope of operations aims to assist in achieving national security priorities while equipping its clients with the capabilities they demand to guard and progress society.
Specifically, the company’s core operations include the supply of space systems, state-of-the-art aircraft, missile defense, various weapons, and other mission-critical services, such as artificial intelligence, advanced computing, and cybersecurity.
I am neutral on the stock.
Current Environment
Aerospace & defense contractors are currently in the spotlight as a result of the ongoing unfortunate war in Ukraine. With Western governments assisting Ukraine with all kinds of weaponry and relevant equipment, defense contractors are enjoying unprecedented levels of demand.
Further, Western allies will need to replenish their arsenal following the constant deliveries, which should result in a growing backlog for defense giants like Northrop Grumman. In turn, this should translate to relatively secure revenues over the long term.
Amid the ongoing global geopolitical turmoil, the pentagon’s R&D budgets should also grow, moving forward. A recent example is that spending on Northrop’s latest intercontinental ballistic missile (ICBM), the Ground Based Strategic Deterrent, is going to rise by about one-third next year, to $3.6 billion.
Latest Results
Northrop Grumman entered Fiscal 2022 on a high note, despite the seemingly softer sales year-over-year. In Q1, revenues declined 3.9% to $8.8 billion. Specifically, revenues from Aeronautics Systems fell 10% to $2.7 billion compared to last year due to lower volume in both Manned Aircraft and Autonomous Systems.
Defense Systems’ revenues also declined 18% to $1.3 billion, principally due to the lower scope of an international training program. Revenues from Mission Systems also came in softer, declining 4% to $2.5 billion. However, the decline was due to the sale of the company’s IT Services business.
Finally, revenues from Space Systems rose 13% to $2.9 billion. Higher revenues in the segment were driven by higher sales in both the Launch & Strategic Missiles and Space business areas.
Despite what appears like a disappointing quarter from a sales standpoint at first glance, revenue growth is hardly a good indicator for a contractor. The company’s backlog and profitability prospects are much more important.
Specifically, during Q1 alone, the company booked $8.5 billion in net awards, leading to its total backlog totaling $75.8 billion. This represents more than two years’ worth of future revenues (book-to-bill) for the company. Thus, its short to medium-term performance should remain robust.
Further, in Q1’s conference call, management mentioned that revenue growth should accelerate in 2023, and by 2024, they expect the operating margin rate to be approximately 12%. This is a very juicy margin for any contractor, which should result in resilient profitability. Thus, the tailwinds arising from the ongoing war will peak in a couple of years. Don’t forget that the company is currently servicing its existing backlog.
Dividend & Valuation
Northrop’s future revenues have been rather predictable, historically, as a result of the company’s underlying backlog. Accordingly, management has managed to provide growing capital returns to shareholders.
Impressively, Northrop has hiked its dividend for 18 consecutive years, with the 10-year dividend per share CAGR (compound annual growth rate) standing at 12.3%. The growth rate becomes even more impressive when we consider how mature the company is.
In its Q1 results, Northrop reiterated its Fiscal 2022 guidance, estimating revenues to land between $36.2 billion and $36.6 billion. Adjusted EPS is also estimated to be between $24.50 and $25.10.
The midpoint of management’s adjusted EPS guidance ($24.8) and Northrop’s current DPS run-rate ($6.92) suggests a rather comfortable payout ratio of nearly 28%. Thus, despite the so-far impressive hikes, there should be enough room for the company to continue pursuing double-digit dividend growth ahead.
Besides that, the midpoint of management’s adjusted EPS guidance also suggests that shares are trading at a forward P/E of around 19.3 at their current levels. On the one hand, this may not look like an excessive valuation multiple, especially considering the ongoing tailwinds and the company’s strong dividend growth prospects.
On the other hand, this multiple seems to have priced in most of these tailwinds already. For content, the stock’s forward P/E over the past decade has averaged close to 15-16. Thus, there could be little to no “easy” upside for investors left.
Wall Street’s Take
Turning to Wall Street, Northrop Grumman Stock has a Moderate Buy consensus rating based on six Buys and six Holds assigned in the past three months. At $488.33, the average Northrop Grumman price target implies just 1.9% upside potential.
Takeaway
In my view, Northrop Grumman is a best-in-breed company in the aerospace & defense sector, exhibiting a decades-long track record of exceptional shareholder value creation. The ongoing benefits from the unfortunately continuous war in Ukraine should further strengthen the company’s overall performance and profitability in the coming years.
That said, Mr. Market may have already fully priced the current tailwinds, with shares currently trading near all-time high levels. The stock’s valuation multiple has extended notably, as a result, which could endanger investors’ margin of safety. Thus, while I support that Northrop Grumman makes for a trustworthy long-term investment, I wouldn’t allocate capital to the stock today.
