BUY-rated Northrop Grumman Corp. (NYSE: NOC) is a leading global defense contractor with a focus on aerospace and, increasingly, electronic programs, including cybersecurity. Management has a history of meeting and beating analyst expectations, as it did in 2Q. The shares are susceptible to headlines about cuts in defense spending and budget ceilings, as well as tweets and threats about trade and tariffs.
Management also has a history of raising the dividend, with a clear focus on delivering returns to shareholders. NOC’s multiples are now slightly below industry averages, and we think the stock merits a premium valuation.
The beta on NOC is 0.80.
The company recently posted 2Q EPS that increased 19% year-over-year and topped Street expectations. On July 30, Northrop reported that 2Q revenue increased 5% to $8.9 billion. Segment operating income rose 4%, as the segment operating margin narrowed by 10 basis points to 11.6%. GAAP EPS rose 19% to $6.01, ahead of the consensus forecast of $5.32. For the first half, on a GAAP basis, the company earned $11.16 per share. Adjusted pro forma EPS, excluding a $0.33 charge for negative returns on marketable securities related to benefit plans, was $11.49.
Management also reported net awards in 2Q20 of $14.8 billion, compared to $7.9 billion in 1Q20. The total backlog increased 9% quarter-over-quarter to $70 billion.
Management also expects revenue growth of 4%-5%; a segment operating margin in the low to mid-11% range.
EARNINGS & GROWTH ANALYSIS
Northrop Grumman now has four reporting segments: Aeronautics Systems (31% of sales), which includes military aircraft and space systems; Mission Systems (26%), such as control rooms and cyber solutions; Defense Systems (20%), such as logistics, systems security and fraud detection; and Space Systems (22%), which includes the Orbital ATK space and munition operations.
All segments except for Defense Systems posted year-over-year revenue growth in 2Q. The Aeronatics Systems division grew revenue 7% on a pro forma basis, due to higher sales in both Autonomous Systems and Manned Aircraft. The Defense Systems division’s revenue declined 2% due to lower volume in Battle Management & Missile Systems. Mission Systems revenue rose 2% due to higher sales in Airborne Sensors & Networks. Space Systems revenue rose 15%, due to higher sales in both Space and Launch & Strategic Missiles.
Operating margins widened in the Mission Systems and Defense Systems segments. For 2020, we look for margins to narrow a bit.
FINANCIAL STRENGTH & DIVIDEND
Northrop pays a dividend. The company typically reviews the dividend in May. In May 2020, it boosted the payout by 10% to the current quarterly rate of $1.45 per share.
MANAGEMENT & RISKS
Kathy J. Warden, the former president & COO, became CEO, President and Chairman on January 1, 2019, replacing Wes Bush, the CEO since 2010. David Keffer is the CFO. Prior to joining Northrop Grumman, Keffer was a general partner at Blue Delta Capital Partners. He also previously served as the chief financial officer of CSRA, Inc. Investors in NOC shares face risks. About 80% of the company’s current backlog comes from U.S. government contracts. However, NOC and other defense contractors have been expanding internationally to offset volatile U.S. defense spending trends, particularly on short-cycle programs.
Northrop Grumman is a leading global defense contractor, providing systems integration, defense electronics, information technology, and advanced aircraft and space technology. The company has 90,000 employees.
NOC’s multiples are now slightly below industry averages.
Our revised dividend discount model points to a value above $450 per share. Blending our valuation approaches, we arrive at our target price of $395.