Foolish Forecast: Northrop Grumman

If investing in the military-industrial complex is your thing, then this week is just heaven for you, as all the big boys come out with their quarterly numbers. Next up: Northrop Grumman (NYSE: NOC  ) releases its Q2 2006 earnings results bright and early tomorrow morning.

What analysts say:

  • Buy, sell, or waffle? Two dozen analysts track Northrop, but a full score of them just think you should hold it. Of the rest, two say buy and two say sell.
  • Revenues. They expect sales to decline 2% to $7.8 billion in the second quarter.
  • Earnings. Profits, however, are expected to rise 8% to $1.08 per share.

What management says:
According to CEO Ronald Sugar, Northrop got off to something of a sweet start this year (apologies -- that was truly unforgivable).

The firm's information and services, aerospace, and electronics divisions each produced strong operating profits, while the ship-building division continues to build back toward where it was before Katrina wrecked operations last year. Even with the weakness in ships that caused a decline in revenues, the firm improved its overall operating margin in Q1 (versus last year), and Sugar now predicts "double-digit growth in earnings per share and substantial cash generation in 2006." More specifically, the latest predictions call for 2006 sales of $31 billion, EPS of as much as $4.40, and at least $2.3 billion in operating cash flow.

What management does:

Lower sales and higher costs to repair a division heavily damaged by hurricanes doesn't sound like much of a formula for success, and yet Northrop has improved its rolling net margins by 80 basis points over the past 18 months. How? It all starts at the top line, where we saw sales fall 2% year over year in the last six months. Cost of goods sold, however, declined by 3%, helping to expand the gross margin. Between that better starting point at the top of the income statement and the fact that operating costs are so much less than the cost of goods sold at Northrop, the firm's 13% rise in operating costs hasn't been enough to hurt the rolling operating or net numbers significantly.

Margins %

12/04

3/05

6/05

9/05

12/05

3/06

Gross

15.8

16.2

16.5

16.2

16.7

17

Op.

6.9

7.2

7.5

7.1

7.1

7.2

Net

3.6

4.2

4.3

4.4

4.6

4.4

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
Numbers aside -- I'm not saying they're bad, because they aren't -- I like Northrop for the serious technological progress it's making with its weapons systems and the directions it's taking with this. What stood out most in last quarter's earnings report, to this Fool's mind, was the fact it reported successfully completing "nine autonomous shipboard landings on board USS Nashville" by the firm's RQ-8A Fire Scout unmanned aerial vehicles (UAVs).

The Fire Scout landings are significant for several reasons. First, in contrast to the firm's Global Hawk UAVs, Fire Scouts resemble miniature helicopters rather than miniature airplanes. That makes these units more suitable for long-duration surveillance missions (because by hovering rather than circling, the units are likely to attract less attention from the ground). It also expands the range of surface ships from which units could be launched and recovered -- less flight deck area being needed for the recovery. Also remarkable is that the Fire Scouts managed to land on moving targets and that they did so without being operated by human pilots.

I strongly suspect we will see the military continue to emphasize UAV development and to use it as not just a supplement, but as an alternative to pilot-operated aircraft. Northrop's leading role in the development of these products only makes me more confident in the firm's prospects.

Competitors

  • Boeing (NYSE: BA  )
  • General Dynamics (NYSE: GD  )
  • Honeywell (NYSE: HON  )
  • L-3 (NYSE: LLL  )
  • Lockheed Martin (NYSE: LMT  )
  • Raytheon (NYSE: RTN  )

Read more Foolish musings about truly "mechanical" investing in robot-makers:

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Fool contributor Rich Smith does not own shares of any company named above.


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