Morningstar | We Assign Northrop Grumman a Wide Economic Moat and a $297 Fair Value Estimate. See Updated Analyst Note from 04 Jun 2019
We assign Northrop Grumman a wide economic moat and a $297 fair value estimate. We think Northrop and Orbital's combined backlog of over $53 billion should translate into top-line growth. The innovation systems unit, as well as Northrop's aerospace systems and mission systems businesses, should drive growth. The F-35 continues to be a revenue driver, but its growth rate is decelerating. We forecast the F-35 to grow at a mid- to high-single-digit rate in 2019, and Northrop has guided to only mid-single-digit growth for 2020. We expect the firm's other flagship program, the B-21 bomber, to generate flat revenue in 2019 versus 2018, but since the program is margin-dilutive, this should actually boost margins slightly. Based on the fiscal 2020 budget request, we believe 2020 B-21 revenue will increase year over year. That said, the real earning power of the B-21 won't occur until the middle of next decade, when production ramps on a fixed-price contract.Following Northrop's closure of the Orbital ATK acquisition, we've integrated it into our forecasts, resulting in a 6% average annual growth rate from 2019 to 2023. However, controlling for the acquisition reveals an average growth rate closer to 4% from the combined Northrop and Orbital ATK entity. That said, we think organic growth will hover around 5% in 2019 and 2020 as higher defense budgets translate into contractual outlays and Northrop continues to churn through its F-35 backlog while ramping up development on the B-21. However, these growth rates are some of the lowest in our defense coverage universe. We project consolidated operating margins to fall year over year in 2019 due to the integration of Orbital ATK as well as an increasing mix of lower-margin development programs, but we forecast margin expansion in 2020 and another increase in operating margins for 2021. After 2021 we model declining margins as we move to our normalized year of 2023, which assumes operating margins land at just below 12%.
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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