Shareholders of Huntington Ingalls would probably like to forget the past six months even happened. The stock dropped 24.1% and now trades at $187.80. This was partly due to its softer quarterly results and may have investors wondering how to approach the situation.
Is there a buying opportunity in Huntington Ingalls, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.Even with the cheaper entry price, we're swiping left on Huntington Ingalls for now. Here are three reasons why we avoid HII and a stock we'd rather own.
Why Do We Think Huntington Ingalls Will Underperform?
Building Nimitz-class aircraft carriers used in active service, Huntington Ingalls (NYSE:HII) develops marine vessels and their mission systems and maintenance services.
1. Weak Backlog Growth Points to Soft Demand
Investors interested in Defense Contractors companies should track backlog in addition to reported revenue. This metric shows the value of outstanding orders that have not yet been executed or delivered, giving visibility into Huntington Ingalls’s future revenue streams.
Huntington Ingalls’s backlog came in at $49.42 billion in the latest quarter, and over the last two years, its year-on-year growth averaged 1.2%. This performance was underwhelming and suggests that increasing competition is causing challenges in winning new orders. 
2. Free Cash Flow Margin Dropping
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
As you can see below, Huntington Ingalls’s margin dropped by 6 percentage points over the last five years. This along with its unexciting margin put the company in a tough spot, and shareholders are likely hoping it can reverse course. If the trend continues, it could signal it’s becoming a more capital-intensive business. Huntington Ingalls’s free cash flow margin for the trailing 12 months was 1.7%.
3. New Investments Fail to Bear Fruit as ROIC Declines
ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
We typically prefer to invest in companies with high returns because it means they have viable business models, but the trend in a company’s ROIC is often what surprises the market and moves the stock price. Over the last few years, Huntington Ingalls’s ROIC has decreased. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.
Final Judgment
Huntington Ingalls falls short of our quality standards. Following the recent decline, the stock trades at 10.6× forward price-to-earnings (or $187.80 per share). While this valuation is reasonable, we don’t see a big opportunity at the moment. There are better stocks to buy right now. Let us point you toward KLA Corporation, a picks and shovels play for semiconductor manufacturing.
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