Earnings Preview: Northrop Grumman - Analyst Blog

Los Angeles-based leading shipbuilder and defense contractor Northrop Grumman Corporation (NOC) is among the last of the major defense players yet to release its fourth quarter and fiscal 2010 numbers. The company is slated to release its fiscal 2010 numbers on February 9, 2011.

The Zacks Consensus Estimate for the fourth quarter is $1.01, representing a year-over-year decrease of 19.8%. The Zacks Consensus Estimate for 2010 is $5.98, up 17.5%. Northrop Grumman has had a mixed track record with regard to surpassing earnings estimates in the last four quarters with a trailing four-quarter average of 1.01%.

Third Quarter 2010 Recap

Northrop Grumman's third quarter 2010 results of $1.64 per share were above both the Zacks Consensus Estimate of $1.46 and year-ago earnings of $1.52. The upside in earnings came from improvement in cost structure and better performance from all the segments barring Shipbuilding. The decline was primarily due to lower performance for expeditionary warfare programs.

Sales remained at the same level of $8.7 billion versus the year-ago quarter, ahead of the Zacks Consensus Estimate of $8.6 billion. Earnings from continuing operations increased to $489 million from $464 million in the year-ago period. Net earnings increased to $497 million compared to $490 million in the prior-year period.

Aerospace Systems sales increased 7.1% year over year to $2.7 billion, principally due to higher volume for manned and unmanned aircraft programs. Electronic Systems sales increased 1.9% to $2 billion due to higher sales of targeting and postal automation systems.

Information Systems sales of $2.1 billion were 0.2% higher than the year-ago period principally due to higher volume for defense systems. Shipbuilding sales increased 1.2% to $1.7 billion. Technical Services sales increased 25.9% to $871 million due to higher volume for integrated logistics and modernization programs.

Following the release of third quarter results, management raised the revenue guidance for fiscal 2010 to about $34.9 billion from the earlier guidance of $34.8 billion. It has also updated its EPS guidance range to $6.85 - $7.00 from its earlier range of $6.60 - $6.80.

Agreement of Estimate Revisions

Estimate revisions for Northrop Grumman have been going down over the past month. Over the past thirty days, two analysts have revised their earnings estimates downward for the final quarter of 2010. The annual estimates for 2010 too have witnessed a similar trend with 2 lowering estimates.

There are a number of reasons influencing the negative sentiment regarding Northrop Grumman. On the micro level the company is going through an internal restructuring to focus more on robotic systems, information technology and high-end surveillance equipment.

The company is also contemplating divesting its shipbuilding assets, which provide bleak growth prospects in the near term. Also the company will digest a one-time pre-tax charge of $230 million in the final quarter of 2010 in connection with replacing dearer debts. In November 2010 the company replaced approximately $1.4 billion of debt with average weighted coupon rate of 7.4% with new debts with an average weighted coupon rate of 3.3%.

At the macro level the U.S. Department of Defense's efficiency drive looms on the defense and aerospace players, who have projected a bleak outlook for the future. The Boeing Company (BA) bogged down by the delayed commercial launch of its Dreamliner aircraft and threat of defense cutbacks has projected lower profits for 2011. The cautious trend was followed by other defense bigwigs like Lockheed Martin Corporation (LMT) impacted by projected cutbacks on its biggest program, the F-35 Joint Strike Fighter.  

Magnitude of Estimate Revisions

All the above news has triggered a steady fall in estimate for the fourth quarter of 2010 to $1.01 versus an estimate of $1.51 three months ago. Estimates for 2010 have also followed the same pattern and shrunk to $6.52 from $7.00 three months ago.

Our Recommendation

We believe that Northrop Grumman is fundamentally a sound company and has a strong market position, but we are cautious about near-term bumps. The company currently is trading at a discount to both the peer group and the S&P 500, based on forward earnings estimates.

Northrop Grumman currently has a dividend yield of 2.7%. This is higher compared to other large cap defense companies like Empresa Brasileira de Aeronáutica S.A. (ERJ) and Boeing who have yields of 0.5% and 2.4%, respectively.

Northrop's product line is well positioned in high priority categories, such as defense electronics, next-generation ships, unmanned aircraft and missile defense. Revenue and earnings growth continues to be driven by its strong presence in the current focus areas of cyber security, intelligence, surveillance and reconnaissance.

However, we believe all the above positives have already been taken into account. Currently the stock is moving laterally due to the absence of any positive trigger. We believe the trend would continue in the near term and thus retain a short-term (1 to 3 months) Zacks #3 Rank (“Hold”) on the stock. We are also maintaining our long-term Neutral recommendation on the stock

 
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