Huntington Ingalls Bags $1.5 Billion Warship Contract

According to recent media reports, the U.S. Navy has just floated a plan to grow its battle fleet from the current 273 warships to 355 -- an increase of 82 ships. So file this story under "one down, 81 to go."

On Monday, the Pentagon issued its regularly scheduled daily digest of contracts awarded to defense contractors. Topping the list was a $1.46 billion award to Huntington Ingalls (HII 0.50%) to proceed with construction of USS Fort Lauderdale (LPD 28).

LPD 17 -- lead ship of the San Antonio class -- at sea. Image source: U.S. Navy.

USS Fort Lauderdale and its maker

Described as an "amphibious transport dock," Fort Lauderdale belongs to a class of warships designated LPD (for "landing platform dock"), and that is sometimes referred to as the "LPD 17-class" (so named because the lead ship of the class was LPD 17), and other times as a "San Antonio-class ship" (because LPD 17 is named the USS San Antonio). Its purpose is to carry hovercraft, amphibious tanks, helicopters, and tilt-rotor aircraft filled with Marines to assault hostile beachheads. Huntington Ingalls is the sole builder of San Antonio-class warships in the U.S.

That being the case, it's no great surprise that Huntington Ingalls was chosen to build this ship. Still, the contract is great news for the company, which up until last year had been worrying no one would get to build the new LPD -- because the Navy would not order it. These worries faded a bit last year, when the Navy gave Huntington a small down payment to begin purchasing parts needed to build the warship. Now the worries have been laid permanently to rest, with the award of the full construction contract.

Data source: Yahoo Finance.

At the same time, the news is pretty great for taxpayers. Last we heard, the Navy was estimating LPD 28 would cost it as much as $2 billion to build. Instead, the $1.46 billion award announced Monday, which "subsumes" the Navy's initial $270 million down payment, appears to offer taxpayers a 25% discount off the initially expected price.

But what does it mean for investors?

What it means for investors

San Antonio-class warships come out of Huntington's Ingalls shipbuilding unit, the smaller of the company's two main business units, but by far the more profitable. According to data from S&P Global Market Intelligence, Ingalls-built ships earn robust 17.3% operating profit margins for Huntington -- nearly twice the 9% operating profit margin at the company's other business, Newport News.

That being the case, even at the cut-rate price Huntington is offering the Navy, investors can expect to see Huntington reap profits of as much as $252 million from this single contract -- nearly 60% of the net profit Huntington Ingalls generates from its entire business over the course of a year.

Should you buy Huntington Ingalls stock?

Granted, these profits will actually be spread over six years' time (the Pentagon has set an October 2021 completion date for Fort Lauderdale's construction). Even so, winning this contract is clearly a big deal for Huntington Ingalls. But is it a big enough deal to justify buying the stock?

Not necessarily. To know whether Huntington Ingalls stock is a buy, you need to look beyond any one contract, no matter how profitable, and examine the valuation of the stock as a whole. So let's do that:

Data sources: Yahoo Finance, S&P Global Market Intelligence.

As you can see, Huntington Ingalls' valuations are all over the place. On one hand, the stock's price-to-sales ratio -- 1.2 -- sits uncomfortably above my usual rule of thumb for investing in defense stocks, that the P/S ratio be 1.0 or lower. Huntington's dividend yield is also a bit low for a defense contractor. Archrival General Dynamics, for example, pays 1.7%, while Lockheed Martin -- also a force in naval shipbuilding -- pays a much more generous 2.9% dividend yield.

On the other hand, though... just look at that growth rate! 27.5% growth, if Huntington achieves it, is sufficient to justify a lot of otherwise unacceptable valuation ratios, and certainly fast enough growth to render a 20.6 P/E ratio -- much less a 13.6 P/FCF ratio -- acceptable. The key will be to see if Huntington Ingalls can achieve the growth rates that Wall Street is expecting from it.

At the very least, the $1.46 billion that Huntington will collect from the USS Fort Lauderdale contract should help make that growth rate more achievable.

(For more on this story, tune back in to The Motley Fool bright and early tomorrow).