Could This Next-Generation Bomber Help Northrop Grumman?

Yes, sales are down, but they may not stay that way for long.

Jul 26, 2014 at 10:31AM

RQ-4 Block 20 Global Hawk first flight taxiing down runway. Photo credit: Northrop Grumman. 

Northrop Grumman (NYSE:NOC) reported its second-quarter 2014 earnings on Wednesday, July 23. The good news is that net income increased 5% to $511 million, up from $488 million for the same time last year, and Northrop increased its earnings per share, or EPS, guidance to a range of $9.15-$9.35, up from $$8.90-$9.15.

The bad news is Northrop Grumman's aerospace systems, electronic systems, and information systems business segments all saw a decrease in sales, resulting in a quarterly revenue dip of approximately 4%. Plus, Northrop Grumman's total backlog as of June 30 was $35.6 billion, down from $36.2 billion as of March 31, and down from $37.7 billion for this same time last year -- but, is there reason to think this could improve?

A look at Northrop
Without question, of its four business segments, Northrop Grumman's most profitable is aerospace systems. Unfortunately, for its latest quarterly report, Northrop Grumman reported that sales in this segment decreased 4.2%: "Lower unmanned sales reflect volume declines for several programs, including Global Hawk and Fire Scout," as well as, "Lower space sales reflect volume declines for several space programs, including Advanced EHF."

Furthermore, Northrop Grumman's second-highest business segment, electronic systems, reported a sales decline of 1.5% due to "fewer deliveries of navigation and maritime systems and infrared countermeasures products," and its third-highest business segment, information systems, reported a 7.5% decline thanks to "lower funding levels and in-theater force reductions." Clearly, this isn't the best news for Northrop Grumman's investors, but here's why there's still reason for hope.

Upcoming awards and escalating tensions
As I previously detailed, the Air Force recently released a request for bids for a next-generation stealth bomber, called the LRS-B. Additionally, the contract could be worth over $80 billion, including research and development. More importantly, it's rumored that one of the things the Air Force wants in the LRS-B is the option of being unmanned. The reason this is good news for Northrop Grumman is that when it comes to unmanned systems, no one beats it.


Next-Generation Bomber concept. Photo credit: Boeing.

Even if Northrop Grumman loses the LRS-B to a competitor like Boeing or Lockheed Martin, the current escalating crisis in Iraq, as well as tensions between the United States and Russia, have further emphasized why adequate defense spending is necessary to national security. Consequently, while a defense-spending bill for fiscal year 2015 has yet to make it past both the House and the Senate, the most recent bills to come out of these legislative bodies have specifically rejected many of the Pentagon's cost-cutting measures. 

Moreover, as I've previously detailed, if tensions in Iraq continue to increase, the United States could fund increased military action through the use of emergency funding. Considering that between 2000 and 2010, the wars in Iraq and Afghanistan were largely funded through emergency spending bills, which exceeded $980 billion, this could be a significant boost to defense spending.  

Battle of the budget
One of the big problems facing not only Northrop Grumman, but also defense contractors in general, is defense budget cuts, courtesy of the Budget Control Act of 2011. As such, reduced sales are predictable. However, as I've outlined above, thanks to escalating tensions, as well as a need to replace older weapons systems, there is reason to believe that Congress will find a workaround. That's not to say Northrop Grumman's woes are over -- investors would do well to continue monitoring Northrop Grumman's backlog -- but it is to say that there appears to be hope on Northrop Grumman's horizon. Consequently, while there's still reason for concern regarding Northrop Grumman's immediate future, it still has long-term potential.

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Katie Spence owns shares of Northrop Grumman. The Motley Fool owns shares of Lockheed Martin and Northrop Grumman. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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