Northrop Grumman Corporation (NOC) is an international aerospace & defense company specializing in providing a broad range of products and services to the U.S. Department of Defense (DoD) and other international governmental entities.
The company’s diversified operations are aligned to aid national security priorities and equip its customers with the capabilities they require to protect and advance society.
Northrop Grumman’s primary operations comprise the provision of space systems, advanced aircraft, missile defense, state-of-the-art weapons, mission systems, artificial intelligence, advanced computing, and cybersecurity.
In my view, Northrop Grumman is one of the highest-quality companies in the aerospace & defense sector, featuring a decades-long track record of impressive shareholder value creation.
The company is set to benefit from the ongoing war in Ukraine, as Western governments supply the country with weaponry and relevant equipment. As Western governments replenish their own arsenal amid these deliveries, Northrop should experience a growing backlog.
However, investors have likely fully priced these tailwinds, as the stock’s valuation has expanded notably over the past couple of months. While Northrop Grumman could still be a solid long-term investment, I am neutral on the stock.
Recent Financial Performance
Northrop Grumman’s latest results demonstrated the company’s resilience. While its numbers came in somewhat weaker compared to last year, the company’s backlog and profitability prospects remain very strong.
Revenues for Q4 decreased 15% to $8.6 billion, while adjusted earnings per share fell 9% to $6.00. Specifically, sales declined in every segment besides Space Systems.
Aeronautics Systems revenues declined 25% to $2.6 billion compared to last year due to softer volumes in Manned Aircraft and Autonomous Systems. Defense Systems’ revenues dropped 28% to $1.4 billion as a result of the sale of the company’s IT Services business, fewer working days, and the close-out of the contract at the Army’s Lake City ammunition plant.
Mission Systems’ sales also decreased 8% to $2.52 billion, driven by fewer working days but offset by increased volumes in land systems and infrared countermeasures that boosted performance. Finally, Space Systems saved the day for Northrop, with its revenues growing 4% to $2.7 billion, supported by elevated sales in Launch & Strategic Missiles and Space.
Northrop won $9.8 billion in contracts during the quarter despite the relatively underwhelming results, boosting its total backlog to $76.0 billion. With Northrop’s production capabilities able to deliver approximately $35 billion worth of goods and services annually (i.e., its Fiscal 2021 revenues), the company has a book-to-bill ratio north of two years.
This implies that the company’s short-to-medium-term cash flows should remain robust. The ongoing macro geopolitical landscape should further strengthen the company’s backlog. For context, the company is estimated to reap $59 billion over six years from a new bomber and an intercontinental ballistic missile alone, conditional on the U.S. Air Force’s new spending plan being realized.
Dividends, Buybacks & Valuation
Due to Northrop’s forthcoming revenues being based on the underlying backlog, the company’s performance has historically been quite stable and predictable. Consequently, the company has been able to gradually return increasing amounts of capital to shareholders over the years.
Specifically, Northrop boasts an 18-year long dividend growth track record. The company has grown its dividend at a rapid pace, featuring a 10-year dividend per share CAGR (compound annual growth rate) of 12.3%. Its latest hike was also by a satisfactory rate of 8.3% to a quarterly rate of $1.57.
Along with its Q4 results, the company provided its Fiscal 2022 outlook, including expected revenues between $36.2 billion and $36.6 billion for the year and EPS between $24.50 and $25.10.
The midpoint of management’s guidance, along with Northrop’s DPS run-rate, indicates a comfortable payout ratio of 27%, which implies that the company should be able to support robust dividend hikes moving forward with ease.
Additionally, the midpoint of management’s guidance also implies a forward P/E of around 18.2 at the stock’s current levels. While the valuation sounds rather reasonable, it simultaneously prices in most of the upcoming tailwinds the company is set to enjoy, in my view. It’s also notably higher than the stock’s historical average forward P/E of around 15-16.
Something worth remembering is that the company’s buybacks should be less effective following the recent valuation expansion. Northrop has constantly repurchased shares over the year, delivering value to its shareholders and gradually boosting its EPS.
Last year the company repurchased a whopping $3.74 billion worth of stock. To provide some perspective, the company has repurchased and retired around over 57% of its common stock since 2004, which is nothing short of impressive. However, buybacks should be less incremental valuable at an expanded valuation (as the company would be slightly overpaying for its shares), which is something worth noting.
Wall Street’s Take
Turning to Wall Street, Northrop Grumman Stock has a Moderate Buy consensus rating based on three Buys and seven Holds assigned in the past three months. At $456.89, the average Northrop Grumman price target implies 1.1% upside potential.
Overall, Northrop Grumman is a quality company with a long history of shareholder value creation. The company should see its backlog expand in the coming years, driven by the ongoing war in Ukraine, which is driving international defense budgets higher.
Nonetheless, the stock’s recent rally has likely fully priced in any upcoming benefits from the current circumstances, thus limiting the potential for extraordinary returns ahead.
Still, I believe that Northrop should be able to serve dividend-growth investors adequately, as its bottom line could comfortably support DPS growth in the high-single to low-double digits moving forward.
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