Buybacks -- they're back! Last week, fellow Fool Anders Bylund took Netflix to task for doubling down on its 2009 share repurchase program. Within days, CVS Caremark announced a $2 billion deal of its own, and now, yet another of Wall Street's biggest names has revealed plans to shrink (its share count.)
Northrop Grumman's (NYSE: NOC) me-too, $2 billion buyback probably needs no explanation ... but just in case, I'll remind you: The Pentagon's on the budgetary warpath. Analysts from Goldman Sachs on down are predicting the demise of defense stocks. If ever there was a time to take aggressive action to defend the stock price (or snap up cheap shares, and enhance shareholder returns), it would be now.
But is it now? As in past discussions, we ask two basic questions:
Can it pay?
In theory, yes. Northrop has $2 billion in cash on hand. It's authorized a $2 billion repurchase plan; the stars seem aligned. Of course, the company also has $4.2 billion in debt to pay off, so Northrop probably won't blow its entire wad all at once. Still, with over $1.1 billion in free cash flow generated over the past year, I suspect that given time and prudent cashflow management, Northrop can pay.
Should
it pay?
Um, no -- and for two good reasons. First, depending on how you define "value," Northrop's stock looks anywhere from modestly overvalued to vastly overpriced today:
|
Company |
P/E |
Price-to-Free Cash Flow |
Projected Growth Rate |
|---|---|---|---|
|
Northrop |
11.1 |
17.0 |
10% |
|
L-3 Communications (NYSE: LLL) |
10.4 |
7.0 |
8.6% |
|
General Dynamics (NYSE: GD) |
10.8 |
10.2 |
7.2% |
|
Lockheed Martin (NYSE: LMT) |
10.7 |
10.7 |
8.4% |
|
Boeing (NYSE: BA) |
40.2 |
11.8 |
8.8% |
Northrop's not as pricey as General Dynamics, Lockheed Martin, or Boeing, but many value investors would agree that paying even an 11 P/E for a 10% grower is a dicey proposition. Worse, value the company on its free cash flow and Northrop is arguably the most expensive stock in the defense industry today.
Beware: Falling stocks
As for the second reason, the Lexington Institute's Loren Thompson warned last week that when you get right down to it: "there is only one customer who matters in the defense business -- the federal government ... any sign of softening demand on the part of that customer raises fear that stock valuations in the sector will erode." Thompson believes such price declines are coming, and a wave of industry consolidation in the offing.
That wouldn't bad for Northrop, necessarily. If management cools its jets, it might get better value for its money a few months from now -- either through buying back its own, cheaper shares, or by snapping up even cheaper rivals, adding their profit streams to its own. Remember: Patience isn't just virtuous; it can also be profitable.
