RTX - Northrop Grumman: Shares Up After Terrorist Attacks On Israel Near Fair Value

2023-10-09 15:25:17 ET

Summary

• Northrop Grumman Corporation had its best trading day versus the S&P 500 since the first trading session following 9/11, reaching multi-month highs, on Monday.
• The aerospace and defense industry rallied due to the conflict in Israel.
• I have a hold rating on Northrop Grumman due to fair valuation and potential overhead supply on the chart.
• Expect several analyst upgrades in the coming days which could support very near-term upside.
• I outline key price levels to watch ahead of earnings due out on October 26.

Northrop Grumman Corporation (NOC) was the top S&P 500 (SP500) gainer in mid-day trading on Monday, October 9. The entire aerospace & defense industry was in rally mode after the attacks on Israel . NOC was up more than 10% to multi-month highs and was on pace for its best single session since immediately after the 9/11 attacks (outside of the COVID-19 crash and GFC). Relative to the S&P 500, the move was the strongest in more than 20 years.

Despite the sudden bullish sentiment around NOC, I have a hold rating on the stock. The valuation appears fair to me and there remains some overhead supply on the chart. Upside catalysts include the probable increase in earnings upgrades on the stock over the coming days and weeks.

NOC: Best Day Outside Of COVID & The GFC In 20+ Years

NOC Vs SPY: Best Day Since Markets Re-Opening Following The 9/11 Attacks

Defense & Energy With Bullish Reactions To The Conflict In Israel

According to Bank of America Global Research, Northrop Grumman Corp is a global defense company headquartered in Falls Church, VA. It provides products, systems, and solutions in information and services, aerospace, and electronics. The company is aligned into four primary businesses, namely, Aerospace Systems, Innovation Systems, Mission Systems, and Technology Services.

The Virginia-based $64.0 billion market cap Aerospace and defense industry company within the Industrials sector trades at a low 14.0 trailing 12-month GAAP price-to-earnings ratio and pays a near-market 1.8% forward dividend yield. Ahead of Q3 earnings due out later this month, shares trade with a moderate 33% implied volatility percentage, up from 24% last week, and shares carry a modest short interest of just 0.9%.

Back in July, NOC reported earnings that were in line with the Wall Street consensus. Revenue grew 9% from year-ago levels, modestly topping estimates. While the management team raised sales guidance by $400 million and firmed up the lower end of its EPS outlook, shares dipped in reaction. The reason for the underperformance post-earnings was its decision not to bid for the Next Generation Air Dominance ((NGAD)) program, but the non-move fits with the firm’s conservative stance toward new projects that could raise costs and hurt margins.

Still, the firm remains a prime player among subcontractors in fighter programs like the F-35 and F/A-18. That move could prove prescient as strong cash flow may allow the company to take part in possible initiatives related to the conflict in Israel. Time will tell, and we will likely hear more on the upcoming Q3 earnings conference call. Importantly for shareholders, the firm had previously stated that it was committed to returning more than 100% of free cash flow to investors in 2023.

On valuation , analysts at BofA see earnings falling 12% this year but then turning into positive-growth territory in 2024 with an acceleration into 2025 – NOC’s management team sees international revenues growing at a double-digit clip over the next several years. The Bloomberg consensus outlook is about on par with what BofA projects, though I would anticipate a slew of analyst upgrades of NOC’s expected EPS due to the sudden conflict in Israel.

Dividends, meanwhile, are expected to climb over the coming quarters, and considering that NOC is highly free cash flow positive, there’s room for additional shareholder accretive activities, including stock buybacks given its strong execution history and solid balance sheet. With earnings multiples that should drift into the mid-teens while EPS is on the rise, the NOC appears to be a reasonable GARP idea.

Northrop Grumman: Earnings, Valuation, Dividend, Free Cash Flow Forecasts

If we assume earnings near $28 and apply an earnings multiple of 18, then the stock’s intrinsic value would be near $500, suggesting not much upside from here. I assert that a slight valuation increase is warranted today given the bullish backdrop of heightened geopolitical tensions and a longer-term thesis that defense spending could increase in the wake of the Russia-Ukraine saga and tensions between China and Taiwan . Still, hitting $28 is not expected until 2025.

A downside risk is that pressure on government spending could hinder that narrative as annual budget deficits continue high. NOC also trades at a lofty price-to-sales ratio versus the industry, though that multiple is not far from the firm’s long-term average.

NOC: Mixed Valuation Metrics, Not A Compelling Value on Earnings

Compared to its peers , NOC has a poor valuation rating, but that masks expected strong earnings trends over the next two years. Moreover, assuming the firm achieves double-digit EPS growth, then that rating should turn closer to its peers. Being large blue-chip firms, profitability trends are strong and many of the industry’s largest players sport decent economic moats and scale.

Still, stock price momentum has been weak lately, though Monday’s jolt should improve that quant grade. EPS revisions are respectable, and further improvement is expected on that front, in my view. Large-cap competitors such as Lockheed Martin (LMT) and RTX Technologies (RTX) trade at cheaper current-year and out-year earnings multiples, too.

Competitor Analysis

Looking ahead, corporate event data provided by Wall Street Horizon for the industry shows several important earnings dates. NOC’s Q3 report is due out on Thursday, October 26 BMO with a conference call immediately after the numbers cross the wires.

Corporate Event Risk Calendar

The Technical Take

With the prospects of large orders and improved profitability in the coming quarters, the chart, like the valuation, is a bit more cautious. Notice in the graph below that shares nicely held support just under the $410 mark last week – before the terrorist attacks in Israel – but there are a pair of possible resistance levels investors must monitor. First, the low $480s was a point of selling in Q1 and Q2 this year, so hurdling that area is important. But even above that, there’s also likely to be some old buyers looking to sell at breakeven beginning near $520 from when the stock was making all-time highs almost a year ago.

What’s encouraging, though, is that the bulls managed to get NOC back above its falling 200-day moving average for the first time since the bearish breakdown in January this year. There’s a reasonable chance that this third attempt to get above $483 could be the one that works. While the stock is an underperformer in 2023, it has beaten the SPX since the market’s correction began in early August. Finally, notice the left side of the chart – there’s a high amount of volume by price down to about $440 – so that should be a buffer against significant downside from current levels.

Overall, there are mixed signals here and I’m not sold that the stock is in a new uptrend.

NOC: Bullish Reaction, But Onus Remains On The Bulls Following Underperformance in 2023

The Bottom Line

I have a hold rating on Northrop Grumman Corporation. The technical chart is mixed, and the valuation merely seems fair to me at current prices. Perhaps the massive jump in response to the tragic attacks against Israel is the unfortunate bullish catalyst the stock has been looking for to attract investors longer-term, but I do not see NOC as a well-rounded buy right now.

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