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Northrop Grumman (NOC) Research Report: Q1 CY2024 Update


Full Report / June 06, 2024

Security and aerospace company Northrop Grumman (NYSE:NOC) reported results ahead of analysts' expectations in Q1 CY2024, with revenue up 8.9% year on year to $10.13 billion. It made a non-GAAP profit of $6.32 per share, improving from its profit of $5.50 per share in the same quarter last year.

Northrop Grumman (NOC) Q1 CY2024 Highlights:

  • Revenue: $10.13 billion vs analyst estimates of $9.76 billion (3.8% beat)
  • EPS (non-GAAP): $6.32 vs analyst estimates of $5.78 (9.4% beat)
  • Gross Margin (GAAP): 21.1%, down from 21.3% in the same quarter last year
  • Free Cash Flow was -$976 million, down from $1.63 billion in the previous quarter
  • Organic Revenue rose 8.9% year on year
  • (5.7% in the same quarter last year)
  • Market Capitalization: $65.47 billion

Responsible for the development of the first stealth bomber, Northrop Grumman (NYSE:NOC) specializes in providing aerospace, defense, and security solutions for various industry applications.

Defense Contractors

Defense contractors typically require technical expertise and government clearance. Companies in this sector can also enjoy long-term contracts with government bodies, leading to more predictable revenues. Combined, these factors create high barriers to entry and can lead to limited competition. Lately, geopolitical tensions–whether it be Russia’s invasion of Ukraine or China’s aggression towards Taiwan–highlight the need for defense spending. On the other hand, demand for these products can ebb and flow with defense budgets and even who is president, as different administrations can have vastly different ideas of how to allocate federal funds.

Northrop Grumman’s peers and competitors include Boeing (NYSE:BA), Raytheon (NYSE:RTX), General Dynamics (NYSE:GD), and Lockheed Martin (NYSE:LMT).

Sales Growth

Reviewing a company's long-term performance can reveal insights into its business quality. Any business can have short-term success, but a top-tier one tends to sustain growth for years. Northrop Grumman's sales grew at a weak 4.9% compounded annual growth rate over the last five years. This shows it couldn't expand its business in any major way. Northrop Grumman Total Revenue

We at StockStory place the most emphasis on long-term growth, but within industrials, a stretched historical view may miss cycles, industry trends, or a company capitalizing on new catalysts such as a contract win or a successful product line. Northrop Grumman's annualized revenue growth of 6.6% over the last two years is above its five-year trend, but we were still disappointed by the results.

We can dig further into the company's sales dynamics by analyzing its organic revenue, which strips out currency fluctuations and one-time events like acquisitions because they don't accurately reflect the company's demand. Over the last two years, Northrop Grumman's organic revenue averaged 6.7% year-on-year growth. Because this number aligns with its revenue growth, we can see the company's core operations drove most of its performance. Northrop Grumman Year-On-Year Organic Revenue Growth

This quarter, Northrop Grumman reported solid year-on-year revenue growth of 8.9%, and its $10.13 billion of revenue outperformed Wall Street's estimates by 3.8%. Looking ahead, Wall Street expects sales to grow 3.6% over the next 12 months, a deceleration from this quarter.

Operating Margin

Northrop Grumman has managed its expenses well over the last five years. It demonstrated solid profitability for an industrials business, producing an average operating margin of 10.8%.

Analyzing the trend in its profitability, Northrop Grumman's annual operating margin decreased by 4.9 percentage points over the last five years. Even though it's already high, shareholders will want to see Northrop Grumman grow its margin in the coming years.

Northrop Grumman Operating Margin (GAAP)

This quarter, Northrop Grumman generated an operating profit margin of 10.6%, in line with the same quarter last year. This indicates the company's overall cost structure has been relatively stable.

EPS

Analyzing long-term revenue trends tells us about a company's historical growth, but the long-term change in its earnings per share (EPS) points to the profitability of that growth–for example, a company could inflate its sales through excessive spending on advertising and promotions.

Northrop Grumman's EPS grew at a weak 2.2% compounded annual growth rate over the last five years. , lower than its 4.9% annualized revenue growth. However, this alone doesn't tell us much about its day-to-day operations because its operating margin actually expanded.

Northrop Grumman EPS (Adjusted)

We can take a deeper look into Northrop Grumman's earnings to better understand the drivers of its performance. As we mentioned earlier, Northrop Grumman's operating margin was flat this quarter but declined by 4.9 percentage points over the last five years. This was the most relevant factor (aside from revenue) behind its lower earnings; taxes and interest expenses can also affect EPS but don't tell us as much about a company's fundamentals.

Like with revenue, we also analyze EPS over a more recent period because it can give insight into an emerging theme or development for the business. For Northrop Grumman, its two-year annual EPS declines of 2.1% mark a reversal from its five-year trend. These results were bad no matter how you slice the data.

In Q1, Northrop Grumman reported EPS at $6.32, up from $5.50 in the same quarter last year. This print beat analysts' estimates by 9.4%. Over the next 12 months, Wall Street expects Northrop Grumman to grow its earnings. Analysts are projecting its EPS of $24.11 in the last year to climb by 5.4% to $25.41.

Cash Is King

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.

Northrop Grumman has shown decent cash profitability, giving it some flexibility to reinvest. The company's free cash flow margin averaged 6.4% over the last five years, slightly better than the broader industrials sector.

Taking a step back, we can see that Northrop Grumman's margin dropped by 3.3 percentage points during that time. Northrop Grumman's historical free cash flow profile was attractive, but shareholders are surely hoping for its trend to reverse.

Northrop Grumman Free Cash Flow Margin

Northrop Grumman burned through $976 million of cash in Q1, equivalent to a negative 9.6% margin. The company's cash burn decreased by 3.5% year on year while its free cash flow margin climbed 1.2 percentage points. This dynamic shows Northrop Grumman's management team brought in more revenue this quarter despite spending less cash - a mark of higher efficiency.

Return on Invested Capital (ROIC)

EPS and free cash flow tell us whether a company was profitable while growing its revenue. But was its growth capital-efficient? Enter ROIC, a metric showing how much operating profit a company generates relative to how much money it has raised (debt and equity).

Although Northrop Grumman hasn't been the highest-quality company lately because of its poor bottom-line (EPS) performance, it historically found a few growth initiatives that worked out well. Its five-year average ROIC was 14.3%, impressive for an industrials business.

Northrop Grumman Return On Invested Capital

The trend in its ROIC, however, is often what surprises the market and moves the stock price. Unfortunately, Northrop Grumman's ROIC has decreased over the last few years. We like what management has done in the past but are concerned its ROIC is declining, perhaps a symptom of fewer profitable business opportunities.

Balance Sheet Risk

As long-term investors, the risk we care most about is the permanent loss of capital. This can happen when a company goes bankrupt or raises money from a disadvantaged position and is separate from short-term stock price volatility, which we are much less bothered by.

Northrop Grumman reported $3.06 billion of cash and $16.57 billion of debt on its balance sheet in the most recent quarter. As investors in high-quality companies, we primarily focus on two things: 1) that a company's debt level isn't too high and 2) that its interest payments are not excessively burdening the business.

With $4 billion of EBITDA over the last 12 months, we view Northrop Grumman's 3.4x net-debt-to-EBITDA ratio as safe. We also see its $562 million of annual interest expenses as appropriate. The company's profits give it plenty of breathing room, allowing it to continue investing in new initiatives.

Key Takeaways from Northrop Grumman's Q1 Results

We were impressed by how significantly Northrop Grumman blew past analysts' organic revenue expectations this quarter. We were also excited its revenue outperformed Wall Street's estimates. Zooming out, we think this was an impressive quarter that should delight shareholders. The stock is flat after reporting and currently trades at $442.99 per share.

Is Now The Time?

Northrop Grumman may have had a good quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

We appreciate companies solving complex business problems, but in the case of Northrop Grumman, we'll be watching from the sidelines. Its revenue growth has been uninspiring over the last five years. And while its solid ROIC suggests it has grown profitably in the past, the downside is its diminishing returns show its profitable business opportunities are shrinking. On top of that, its operating margin decline shows the business has become less efficient.

Northrop Grumman's price-to-earnings ratio based on the next 12 months is 17.4x. While one can find things to like about Northrop Grumman, we think there are better opportunities elsewhere in the market. We don't see many reasons to get involved at the moment.

Wall Street analysts covering the company had a one-year price target of $486.68 right before these results (compared to the current share price of $442.99).

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