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Here's Why Northrop Grumman Gained 12.5% in January

By Lou Whiteman - Updated Apr 17, 2019 at 9:37AM

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Investors looked past near-term issues to focus on longer-term opportunities.

What happened

Northrop Grumman (NOC 1.64%) climbed 12.5% in January, according to data provided by S&P Global Market Intelligence, as shares recovered after a miserable 2018 performance. Northrop is well-positioned for the long term, but this is a stock that could struggle to perform in the next few years.

So what

Northrop investors had a difficult 2018, with the company's shares down 21% for the year and off 32% from their April high. Some of the pain was company-specific, with Northrop in the process of integrating its $9.2 billion purchase of Orbital ATK and also in the early stages of some key contracts. But the entire defense sector came under pressure last year, as investors began to temper expectations for future Pentagon budgets.

The company, while releasing earnings late in the month, signaled the caution was justified; it provided initial guidance for sales to climb 5% in 2019 to $34 billion, about $400 million short of consensus estimates. Northrop expects its space business to grow by upwards of 10%, and to generate strong revenue growth from its work on the F-35 Joint Strike Fighter, but said other businesses would be flat to down slightly.

Check out the latest Northrop Grumman earnings call transcript.

Artist rendering of the B-21 bomber in flight

Artist rendering of the B-21 bomber, Northrop Grumman's flagship program, in flight. Image source: Northrop Grumman.

Northrop Grumman has a history of underpromising and then beating revenue guidance, so investors could be forgiven for looking past the light projections. And given the company's exposure to a number of Pentagon priorities, including the new B-21 bomber and a replacement for the Minuteman intercontinental ballistic missile, the longer-term outlook for Northrop Grumman is solid.

Now what

Trading at 14.9 times trailing earnings, a discount to rivals Lockheed Martin, Raytheon, and General Dynamics, Northrop Grumman makes for an intriguing investment. And indeed, much of the January rally was likely a bet by investors that the company's 2018 swoon was overdone.

But Northrop Grumman, for now, is best left to patient buy-and-hold investors. While it is possible it will exceed expectations this year, the real growth is unlikely to arrive before 2021. That's when capital expenditures related to some of its key early-stage programs decrease, and net income and free cash flow should begin what could be a multiyear surge.

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