Northrop Grumman: From Missile-Defense to Spacecraft

08/23/2019 5:00 am EST

Focus: INDUSTRIALS

Richard Moroney

Editor, Dow Theory Forecasts

Northrop Grumman (NOC), the third-largest military-equipment maker in the world, defies the stereotype of the lumbering, stodgy defense contractor in several ways, asserts growth stock expert Richard Moroney, editor of Dow Theory Forecasts.

While about 90% of revenue is defense-related, and Northrop produces plenty of planes and armaments, the concept of “defense” has changed in recent years. Much of Northrop’s work sounds like something out of the technology sector, not the industrials sector.

There’s nothing stodgy about Northrop’s growth. Year-to-year growth averaged 18% for sales and 34% for per-share profits over the last six quarters. The June 2018 purchase of Orbital ATK, a maker of precision weapons, ammunition, missiles, and space-propulsion systems and structures, contributed to the gains.

The Aerospace Systems unit makes aircraft, spacecraft, lasers, and microelectronics. Mission Systems provides multifunction intelligence gathering, surveillance, electronic warfare, space, missile-defense, and cybersecurity systems.

Orbital ATK, the firm purchased last year, became the Innovation Systems unit. A fourth unit, Technology Services, focuses on computer systems and logistics, with 41% of revenue coming from customers other than the U.S. government.

In the six months ended June, Northrop generated 82% of its revenue from the U.S. government, 16% from international customers, and 2% from others.

In each of the last two quarters, Northrop topped the profit consensus by at least 8%. The company exceeded revenue and profit targets in seven of the last eight quarters. In the wake of the June-quarter surprises, sales and profit estimates for this year, 2020, and 2021 have risen.

The consensus now calls for sales growth of 13% and per-share-profit growth of 6% in 2019, followed by growth of at least 6% in sales and at least 14% in earnings in each of the next two years.

With the backlog at $63 billion, up 10% and roughly two years’ worth of revenue, we’re confident in Northrop’s ability to meet sales projections.

At 18 times trailing earnings, Northrop trades roughly in line with its peer group and 15% below its three-year average valuation. We’re happy to pay an industry-average valuation for a stock with a history of steady growth and a high-visibility stream of future revenues.

The company has raised its quarterly dividend six times since the start of 2015 for a total of 89% growth. Despite the aggressive payout, the indicated year-ahead dividend accounts for just 27% of expected 2019 earnings, leaving room for additional hikes.

Northrop also invests in its own shares, reducing the share count 3% over the last year and 21% over the last five years. Northrop Grumman, yielding 1.5%, is a Long-Term Buy.

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