Morningstar | Lackluster Growth, Charges Mar Northrop's 2Q, but We Think Shares Are a Bit Undervalued
Wide-moat Northrop Grumman closed its acquisition of Orbital ATK late in the second quarter, standing up the firm as a new unit christened Innovation Systems on June 7. Controlling for the acquisition, Northrop increased second-quarter revenue 4% year over year and consolidated operating margins declined 100 basis points to an estimated 12.5% (reported margins fell about 190 basis points to 11.6%). Management stuck with its 2018 guidance but did move up its earnings per share outlook to a midpoint of $16.73 due to a lower-than-expected tax rate.We think Northrop’s shares sold off after earnings because of execution challenges and lackluster growth; peers Lockheed's and General Dynamics’ defense businesses posted revenue growth of around 7% this quarter. We are maintaining our $318 fair value estimate, and the shares now look a bit undervalued. Our thesis on Northrop and the U.S. defense sector rests on a view that increases in U.S. Department of Defense budget authority haven’t translated into industry outlays yet; as a result, contractors will post growth higher than consensus estimates through 2018 and into mid- to late 2019. We also like the post-Orbital ATK portfolio that is focused on missile defense and space, and we think Northrop’s aircraft programs (B-21 and F-35) will drive growth despite some near-term margin dilution.
Reported revenue increased 10% year over year, reaching $7.1 billion this quarter. Revenue growth was driven by the inclusion of Orbital ATK and 11% growth at aerospace systems thanks to F-35 volume and classified activities (probably development of the B-21). Technology services’ top line shrank 10% year over year, but mission systems was the real shock, where revenue eked out meager 0.5% growth. Despite unfavorable mix at aerospace systems, margins came in basically flat with last year. However, margins contracted 70 basis points at mission systems and 160 basis points at technology services due to program execution challenges.
Northrop Grumman is a security company. The company's segments include: Aerospace Systems, which is engaged in the design, development, integration and production of manned aircraft, autonomous systems, spacecraft, high-energy laser systems, microelectronics and other systems and subsystems; Innovation Systems, which is engaged in the design, development, integration and production of flight, armament and space systems; Mission Systems, which is engaged in end-to-end mission solutions and multifunction systems; and Technology Services, which is engaged in delivering solutions and services in support of mission-critical networks and systems.
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Morningstar provides data on approximately 530,000 investment offerings, including stocks, mutual funds, and similar vehicles, along with real-time global market data on more than 18 million equities, indexes, futures, options, commodities, and precious metals, in addition to foreign exchange and Treasury markets. Morningstar also offers investment management services through its investment advisory subsidiaries and had approximately $185 billion in assets under advisement and management as of June 30, 2016.
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