NOC - Northrop Grumman: Buy Or Hold On Global Tensions?

2023-11-01 17:51:38 ET

Summary

• Global tensions increase demand for products provided by defense companies like Northrop Grumman.
• Northrop Grumman's Q1 results show sales growth in all segments, with strong performance in Aeronautics and Space Systems.
• Stock analysis suggests Northrop Grumman is fairly valued and should be held.

In May 2023, I marked Northrop Grumman ( NOC ) stock a hold as the stock price had already priced in a lot of forward earnings. In this report, I will be discussing the most recent quarterly results and provide an update to stock price targets and rating if needed.

Global Tensions Rise Even Further

Ideally, the world is in a state of peace and mounting tensions provide a somewhat positive backdrop for defense companies to develop weapon systems that can be used for the purpose of power projection. Currently, the world is beyond that point and we have conflicts in two places on the globe. The impact is devastating as human lives are lost, but for defense companies this increases the demand for weapon system production and development and brings positive sentiment for defense stocks.

Northrop Grumman Earnings Grown In Line With Revenues

The first quarter results showed that overall sales were up with year-over-year growth in all segments. Aeronautics Systems sales were up 9% driven by higher volumes. Defense Systems sales grew by 6% reflecting strong interest in Missile systems while the growth in Mission Systems was similar at 7%, reflecting higher sales for the Network Information Solutions business. Space continued the highest growth segment with an 11% growth in revenues driven by the ramp up on the Ground Based Strategic Deterrent, Next Generation Interceptor and Next-Generation Overhead Persistent Infrared programs.

With the acquisition of Orbital ATK years ago and the demand for space-based global security solutions, commercial satellites and space travel increasing Northrop Grumman is positioned well to benefit now and in the future.

Aeronautics operating income increased by 8% or $21 million. Defense System income increased 15% pointing at significant margin expansion which was driven by positive catch up adjustments in Battle Management & Missile Systems.

Mission Systems income increased by 5% indicating some margin pressure driven by contract mix as Northrop Grumman currently has more programs in the development cost-type phase. Space Systems income increased 8% pointing at some margin erosion as well due to lower favorable catch-up adjustments partially offset by insurance recoveries.

Overall, third quarter results exceeded analyst expectations on revenues by $218.2 million and by $0.38 per share on earnings with 9% sales growth and 8% segment income growth. So, we saw high single-digit growth in sales that with some pressure on margins translated to the bottom line.

Northrop Grumman Guidance Update Looks Somewhat Uninspired

For the full year, Northrop Grumman now expects $39 billion in sales, up around 6.5% year-over-year driven by Aeronautics sales expected to be mid to high $10 billion up from mid $10 billion and Space Systems sales expected to be around $14 billion up from high $13 billion. Mission system margins have been guided to be around 15% from low 15%. Putting it all together it did not lead to any change in segment operating income or cash flow. More positive but not included in the guidance slide is the fact that the company now expects book-to-bill ratio of higher than 1.

Northrop Grumman Stock Price Analysis

Overall, the results showed strong execution with some contract type and mix pressure with free cash flow generation of $900 million during the quarter. For 2024, the company expects around 4% to 5% growth in sales and earnings, and while this is not as high as the projected growth rate for 2023, it's partially driven by some growth materializing earlier than initially anticipated.

Processing the balance sheet data and forward projections show that the company is valued fairly and in line with peers with 2% upside for 2023 and for 2024 there is 13% upside to $528.80 which also is my price target. While I do see upside for the stock, my scoring system still marks Northrop Grumman a hold based on overvaluation compared to its usual EV/EBITDA median providing some downside risk.

Conclusion: Northrop Grumman Stock, I Understand A Buy Sentiment But It's Still A Hold

I perfectly understand bullish views on Northop Grumman and I also see the current defense budget environment as a prolonged positive. However, the company is currently more or less fairly valued and any margin pressure or moderating in revenue growth poses downside risk to the company median. So, while I appreciate management returning value to shareholders via share repurchases and a modest dividend I do think the stock is a hold.

For further details see: