Studying Northrop Grumman Financials

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- By Mark Yu

Northrop Grumman (NOC) reported its third quarter a day after both Lockheed Martin (LMT) and United Technologies (UTX) reported theirs. The $42 billion aerospace and defense company delivered 1.56% sales growth to $18.1 billion and 9.4% profit growth to $1.68 billion.

As observed, general sales growth was offset a bit by Northrop Grumman's overall expenses, which climbed by 2%.



"Our third-quarter results demonstrate that we continue to build a strong foundation for profitable growth over the long term." - Wes Bush, chairman, CEO and president



As a result, Northrop Grumman's shares went up by 3.9% while the broader Standard & Poor's 500 index closed with -0.17% change.

Valuations

Northrup Grumman has a trailing 12-month price-earnings (P/E) ratio of 19.9 times (industry median: 22), price-book (P/B) ratio of 7 times (industry median: 2) and price-sales (P/S) ratio of 1.8 times (industry median: 1.2; 1). The $42 billion defense contractor also had a trailing dividend yield of 1.47% with a 29% payout ratio and 8.8% share buyback ratio.

Market performance

Northrup Grumman has an incredible run both in short- and long-term total returns. On a five-year average, the defense contractor provided an outstanding 34.9% total return vs. the broader index's 14.9% (2). Year to date, Northrup Grumman returned 28% vs. the index's 12.9%.

(Annual Report)

Northrop Grumman

Northrop Grumman was the top five biggest defense contractors in the U.S. in fiscal 2015. The company was obligated with $10.6 billion by the government.

Northrop Grumman was formed when the 55-year-old aircraft manufacturer, Northrop, acquired the older 65-year-old Grumman, a U.S. producer of both military and civilian aircraft, in 1994 (3).

Northrop Grumman is a leading global security company. The company offers a broad portfolio of capabilities and technologies that enable us to deliver innovative products, systems and solutions for applications that range from undersea to outer space and into cyberspace.

The company provides products, systems and solutions in unmanned systems; cyber; command, control, communications and computers (C4), intelligence, surveillance and reconnaissance (C4ISR); strike aircraft; and logistics and modernization to government and commercial customers worldwide.

Northrop Grumman conducts most of its business with the U.S. government, principally the Department of Defense (DoD) and intelligence community. In its filing, Northrop Grumman derived 83% of its sales from the U.S. government in fiscal 2015. The company also conducts business with foreign, state and local governments and commercial customers.

(10-K and 10-Q)

Northrop Grumman has four segments: Aerospace Systems, Electronic Systems, Information Systems and Technical Services.

The company streamlined its sectors from four to three effective Jan. 1 . The streamlining was done to better align its business with its evolving customer needs and also to reflect the improved innovation observed across the company, according to filings (4).

(E-2D Advanced Hawkeye, Northrop Grumman)

Aerospace Systems

Aerospace Systems is a leader in the design, development, integration and production of manned aircraft, unmanned systems, spacecraft, high-energy laser systems, microelectronics and other systems and subsystems.

The segment consists of four business areas: Unmanned Systems, Military Aircraft Systems, Space Systems and Strategic Programs & Technology.

Aerospace Systems had consistently contributed the most in total Northrop Grumman business, averaging 41.6% of total sales over the past three fiscal years. In fiscal 2015, the segment grew 0.1% to $10 billion while delivering a 12.2% operating margin. Three quarters into fiscal 2016, Aerospace Systems grew 5.5% and demonstrated an 11.4% margin, compared to 12.3% a year earlier.

(APG-83 Scalable Agile Beam Radar (SABR) AESA for the F-16, Northrop Grumman)

Electronic Systems (Mission Systems)

Electronic Systems is a leader in the design, development, manufacture and support of solutions for sensing, understanding, anticipating and controlling the operating environment for its global military, civil and commercial customers (5).

The segment consists of the following business areas: Airborne Intelligence, Surveillance, Reconnaissance & Targeting Systems, Space Intelligence, Surveillance & Reconnaissance Systems, Land & Self Protection Systems, and Navigation & Maritime Systems.

Electronic Systems had consistently contributed the second most in total Northrop Grumman business, averaging 29% of total sales over the past three fiscal years. In fiscal 2015, the segment grew -1.6% to $6.84 billion, while delivering a 15.6% operating margin.

Northrop Grumman streamlined its Electronic and Information Systems operation and modified other segments as well, thus resulting into the Mission Systems segment. Mission Systems contributed the largest, 44.6% or $8.08 billion, in total sales so far in fiscal 2016.

Three quarters into fiscal 2016, the now Missions Systems segment grew 0.2% and demonstrated an 13.1% margin compared to 13% a year earlier.

(Airborne SIGINT Product Line, Northrop Grumman)

Information Systems

Information Systems is a leading provider of advanced solutions for the DoD, national intelligence, federal civilian, state, international and commercial customers (6).

The segment consists of seven business areas: Cyber, C2, Communications, ISR, Integrated Air and Missile Defense (IAMD), Civil and Health.

In fiscal 2015, the segment grew -5.3% to $6.22 billion, and had an operating margin of 10.5%. As a result of streamlining early in fiscal 2016, segment operations contributed to what now has been the largest segment year to date, in terms of sales, the Missions Systems segment.

(KC-10 Contractor Logistics Support, Northrop Grumman)

Technical Services

Technical Services is a leader in innovative logistics, modernization and sustainment and also provides an array of other advanced technology and engineering services including space, missile defense, nuclear security, training and simulation.

The segment consists of two business areas: Integrated Logistics and Modernization and Mission Solutions and Readiness.

In fiscal 2015, Technical Services sales grew by 1.4% to $2.84 billion and delivered an operating margin of 8.9%. Nine months into fiscal 2016, the segment grew by -2.2% and delivered a margin of 10.7%.

Overall Northrop Grumman had a five-year sales and profit average of -7.5% and -0.62%.

Cash, debt and book value

Northrup Grumman had $1.1 billion in cash and $6.4 billion in debt or a debt-equity ratio of 1.11 as of Sept. 30 compared to a ratio of 1.16 in December 2015. The company also had 51.7% of its $24.1 billion assets in goodwill and a book value of $5.77 billion for the period compared with $5.5 billion in December 2015.

Cash flow

(10-Q)

Northrop Grumman grew its cash flow from operations by 142% to $1.28 billion nine months into fiscal 2016. As observed, this tremendous cash flow growth was made possible by reduction in excess tax benefits cash allocation, increased inventoried costs, accounts payable and other liabilities and retiree benefits.

Capital expenditures were $608 million compared to $334 million last year, which left Northrup Grumman with $674 million in free cash flow.

Northrop Grumman allocated 242%, or $1.6 billion, of its free cash flow in dividends and share repurchases for the period. Over the years, Northrop Grumman has allocated more of its free cash flow payouts in share repurchases, about 83% since fiscal 2013. On average, the company allocated 173% of its free cash flow in shareholder payouts.

Northrop Grumman also reduced its debt by $152 million for the period.

Conclusion

Slowdown in defense budget allocation affected Northrop Grumman. The company reflected this in its earnings figures over the past several years. Despite this, the company seemed to have a better debt-equity ratio compared to its other bigger peer, Lockheed Martin.

The company also has been very shareholder friendly even in tough times. As discussed, allocation to dividends and buybacks has been bountiful, even exceeding Northrop Grumman's cash flow.

(Google Finance)

A month ago, analysts in Barclays saw Northrop Grumman as an overweight and had a price target set to $270 a share, from an earlier target of $230. Robert W. Baird, meanwhile, saw Northrop Grumman as an outperform and had a $260 per share price back in October.

On the other hand, Northrop Grumman's current earnings multiple suggested that it has been trading higher than its previous historical earnings multiples.

Provided with the overall economic environment surrounding the company's business and unfavorable balance sheet figures, Northrop Grumman is probably a pass.

Notes

(1) GuruFocus data.

(2) Morningstar data.

(3) Wikipedia.

(4) 10-K: Two new sectors were created by merging elements of the former Electronic Systems, Information Systems and Technical Services sectors.

The new Mission Systems sector is composed of the majority of former Electronic Systems sector and the businesses from former Information Systems sector focused on the development of new capabilities for our military and intelligence customers. The services portfolio in the former Information Systems sector was combined with the former Technical Services sector to form the new Technology Services sector.

(5) 10-K: Electronic Systems provides a variety of defense electronics and systems, airborne fire control radars, situational awareness systems, early warning systems, electronic warfare systems, air defense radars and management systems, navigation systems, communications systems, marine power and propulsion systems, space systems and logistics services.

10-K: Information Systems products and services focus on the fields of command and control (C2), communications, cyber, air and missile defense, intelligence processing, civil security, health technology and government support systems.

Disclosure: I do not have shares in any of the companies mentioned.

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This article first appeared on GuruFocus.


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