Stock Analysis & Ideas

Northrop Grumman (NYSE:NOC): War-Driven Earnings Growth is Being Overlooked

Story Highlights

Northrop Grumman’s earnings and backlog have strengthened, driven by the ongoing war in Ukraine. Further, the stock appears undervalued following its recent decline, creating upside potential.

Northrop Grumman’s (NYSE:NOC) earnings growth prospects appear vigorous as the unfortunate war in Ukraine continues to escalate. As one of the major players in the aerospace & defense industry, the company is well-positioned to benefit from the West’s ongoing efforts to supply Ukraine with the weapons and arsenal it needs. However, despite the stock’s strong performance last year as a result of this trend, it has since lost much of its gains.

With shares now trading at an attractive valuation following their recent dip and the company bolstering its share repurchase program in response, I believe there could be significant upside potential from Northrop Grumman, moving forward. Accordingly, I am bullish on the stock.

War in Ukraine to Benefit Earnings, Backlog

Sadly, the ongoing war in Ukraine continues to escalate. For Northrop Grumman and its handful of behemoth aerospace & defense peers, however, this is unsurprisingly positive news. As Western allies remain committed to supplying Ukraine with all the military equipment it needs to turn the tide in the ongoing conflict, they have Northrop on speed dial to ensure a steady flow of weapon and arsenal production.

Consequently, the company has been able to win contracts at an accelerated rate and increase its production backlog, setting the stage for growing revenues and earnings in the coming years. Its most recent earnings results displayed some of these developments, with Northrop posting revenue growth across the board and record adjusted earnings per share.

Revenue Growth Across the Board

For the quarter, total revenues rose by a substantial 16% to $10.0 billion. Specifically, revenues from Aeronautics Systems came in 5% higher compared to last year, at $2.7 billion. Higher sales were driven by increased sales volumes in Manned Aircraft, including higher sales of F-35, partially offset by lower volume in Autonomous Systems.

Defense Systems’ revenues also rose 20% to $1.7 billion, aided by higher sales volumes from the Special Ammunition and Weapon Systems (SAWS) program. Revenues from Mission Systems also grew notably, increasing by 16% to $2.9 billion. The segment’s growth was driven by higher sales in the Networked Information Solutions business area, airborne radar programs, and the Surface Electronic Warfare Improvement Program (SEWIP).

Finally, revenues from Space Systems advanced 23% to $3.3 billion, with sales in the Launch & Strategic Missiles areas growing largely “due to ramp-up on development programs.”

Backlog, Profitability, Outlook

On top of Northrop delivering notable top-line growth across all segments, the ongoing contracts the company has been winning due to the geopolitical landscape and rising defense budgets have allowed the company to grow its order backlog.

In Q4 alone, the company booked $9.1 billion in net awards, boosting its total backlog to $78.7 billion. This represents a 4% increase compared to last year, as well as about 2.2 years’ worth of future sales for the company at its current revenue run rate. Therefore, Northrop’s short to medium-term results should remain very strong, especially with new orders keep coming in.

Additionally, following exceptional top-line growth, Northrop also posted adjusted earnings per share of $7.50, the highest in its history and 25% higher compared to last year.

More importantly, though, management provided quite reassuring guidance, forecasting another year of excellent results. The company expects its Fiscal 2023 sales to land between $38.0 billion and $38.4 billion, suggesting a year-over-year increase of 4.4%.

Further, management projects adjusted earnings per share to be between $21.85 and $22.45. Note that while this implies a decline compared to fiscal 2022’s $25.54, this decline is only due to a $450 million ($4.30 per share) net pension income headwind – a non-operational, non-recurring element.

Valuation Overlooks Earnings Growth Potential

Northrop Grumman’s forward valuation can be a bit misleading and likely overlooks the company’s earnings growth potential. If we apply the midpoint of management’s guidance, the stock appears to be trading at a forward P/E of 20.6. At first glance, this appears to be a relatively fair multiple that takes into account both the ongoing tailwinds benefiting the industry and the headwinds of a rising-rates environment.

That said, if we add back the $4.30 per-share adjustment (which is a non-recurring item) in order to get a more “normalized” view of the company’s earnings, the forward P/E drops to about 17.2 — slightly lower than the industry median forward P/E of 18.2.

In my view, this multiple discounts the company’s prominent position in a favorable (for defense companies) trading environment. Management appears to agree, as immediately after the stock plunged, they announced a $500 million share repurchase program to take advantage of its discounted valuation.

Is NOC Stock a Buy, According to Analysts?

Turning to Wall Street, Northrop Grumman Stock has a Moderate Buy consensus rating based on seven Buys, six Holds, and one Sell assigned in the past three months. At $506.83, the average Northrop Grumman stock forecast suggests 11.3% upside potential.

The Takeaway

The ongoing conflict in Ukraine has created a surge in military equipment demand, resulting in aerospace & defense giant Northrop Grumman being in a favorable position to reap the benefits. The company’s latest results, expanding backlog, and management’s optimistic guidance demonstrate this concept clearly.

Despite Northrop’s promising prospects, the unexpected dip in its stock price might suggest significant upside ahead. Additionally, the recently announced share repurchase program should reinforce investors’ confidence in the fact that the stock is most likely undervalued at its current levels.


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