Morningstar | Northrop Is Digesting Orbital ATK and Ramping Up Its Flagship B-21 Bomber and F-35 Programs
Under the leadership of former CEO Wes Bush, Northrop Grumman's management has executed admirably, in our view, lifting operating margins from the midsingle digits in 2004 to 12.6% in 2018. Moreover, U.S. defense budgetary pressures have lessened, and we forecast U.S. defense spending to rise under the Trump administration. Northrop operates four segments: aerospace systems, mission systems, technology services, and a new innovation systems segment that consists of the Orbital ATK acquisition. Aerospace includes manned (F-35, F/A-18, B-21, B-2) and unmanned (Global Hawk, Fire Scout) aircraft. Mission systems consists of radars, sensors, and systems for surveillance and targeting, including significant content on the F-35. Technology services provides cybersecurity and IT solutions, as well as logistics and maintenance. The company expanded its footprint in satellites, launchers, and missile defense via its $9.2 billion acquisition of Orbital ATK, which closed in the second quarter of 2018. Orbital ATK will operate as a stand-alone unit called innovation systems.The B-21 bomber win (worth $80 billion) positions the firm on a lucrative contract. In addition, we think aerospace systems will return to growth rates above our defense budget forecast, owing primarily to the F-35. As evidenced by the withdrawal from T-X and MQ-25, Northrop continues to bid only on contracts where it think it can drive sufficient returns for shareholders. Northrop was recently selected as a finalist for the GBSD program to replace U.S. land-based nuclear missiles. An outright win on this program could boost our forecast.Despite accelerated growth, Northrop will face margin headwinds due to a mix shift toward cost-plus programs, which are lower margin. Orbital ATK will help offset this unfavorable mix since its program portfolio currently tilts more heavily toward fixed-price contracts. Because of the Orbital ATK deal, share buybacks will not continue at the elevated levels of recent years, but we expect Northrop to remain profitable and generate cash while earning returns above its cost of capital thanks to its wide moat.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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