Boeing (BA -2.87%) and Northrop Grumman (NYSE: NOC) are among the handful of defense contractors that soak up large shares of the Pentagon's hundreds of billions of dollars in annual spending. But their stocks have charted opposite courses this year: Northrop is beating the S&P 500 by more than 20 percentage points so far in 2019, while Boeing trails the index by about 15 percentage points.
NOC and BA data by YCharts
Boeing's most pressing issue is well-known, but there are hits and misses in other parts of its portfolio, too. Northrop, meanwhile, has benefited from a strong multiyear surge in U.S. Defense Department spending, and has notched some key wins that should drive its revenue growth well into the next decade.
Are Boeing shares now on sale ahead of a likely rebound, or is it best to go with a company that's the more straightforward winner today, and favor Northrop shares instead?
Boeing: Navigating through turbulence
The problems of the 737 MAX jet have dominated the news flow surrounding Boeing for most of the year, and with each passing month, the aerospace giant's situation seems to get worse. It's likely that Boeing will eventually get the jet recertified, and the narrowbody aircraft will still go on to be an aviation bestseller. But the damage to Boeing's credibility, and the financial impact from delayed deliveries, compensating suppliers and customers, and dealing with litigation will linger on for years.
The 737 MAX saga alone would be a lot for a company to manage, but unfortunately, Boeing has other troubles to deal with too. Its 777X suffered a recent setback in testing. And its defense unit -- which generates less than 25% of company revenue but still ranks among the nation's largest defense contractors -- has arguably been more prone to mistakes than its commercial arm.
Boeing's KC-46 tanker during a mid-air refueling test. Image source: Boeing.
Boeing finally delivered its long-troubled KC-46 to the Air Force earlier this year, only to have the refueling tanker plane grounded soon after because the company had failed to remove tools and debris from the planes before delivery. Such loose objects, if undiscovered, can damage planes over time. Then, in September, a new major deficit was found involving faulty fasteners that could put crews at risk mid-flight. That discovery caused the Air Force to temporarily bar the tankers from taking on cargo or passengers.
The KC-46 was already years behind schedule and more than $3 billion over budget -- expenses that Boeing had to swallow under its contract. The issues got so bad that then-Air Force Secretary Heather Wilson in 2018 complained to Congress that Boeing appeared to be focused on its commercial cash cow to the detriment of defense. That assertion led to a management overhaul at the unit.
Boeing does have promising projects in production and in development. Its 787 Dreamliner remains a commercial hit, and on the defense side, in the second half of 2018, Boeing won a trifecta of high-profile awards when it was picked to build the Air Force's trainer jet, replace the UH-1N Huey helicopter, and design and build a new Navy refueling drone.
Boeing is a massive company with a portfolio full of promise, but after a series of embarrassing missteps, the question investors must ask themselves is whether the company can fly straight.
Northrop: Is this high flier due to lose altitude?
Northrop Grumman shares are up 43% year to date, fueled by investor optimism the company will win the $60 billion contract to replace the Air Force's intercontinental ballistic missile stockpile and continue to generate revenue from young, developing programs including the $80 billion B-21 bomber.
The company is a defense giant with $30 billion in annual sales across the businesses of aerospace and aviation, space and sensors, information technology, and command-and-control systems and software.
In mid-October, Northrop reported third-quarter earnings that beat expectations by $0.70 per share, but its revenue came in below expectations, and a good portion of that earnings beat was attributable to tax- and pension-related benefits, rather than operations.
Artist rendering of Northrop Grumman's B-21 stealth bomber in flight. Image source: Northrop Grumman.
The company also forecast mid-single-digit percentage sales growth for 2020, which, though vague, seemed more pessimistic than the high-single-digit percentage growth guided for by Raytheon, or the optimistic talk from other defense contractors.
Northrop also recently disclosed it is facing a Federal Trade Commission investigation into its 2018 purchase of Orbital ATK. The companies won FTC approval for the deal in part by agreeing to make Orbital's solid rocket motors available to other companies, but Boeing has complained that Northrop's ownership of Orbital has made it difficult for Boeing to mount a rival bid in the intercontinental ballistic missile competition.
Northrop said it's complying with the investigation, and it's hard to imagine regulators would make Northrop unwind the $9.2 billion Orbital purchase. But the inquiry does create additional uncertainty around Northrop Grumman, and could at worst cost it the giant missile contract -- or at least force it to share the spoils with its rivals.
And the better buy is...
Until Boeing's management team can restore credibility and provide at least a quarter's worth of evidence to suggest they're in control of the company's sprawling portfolio, in my opinion, its shares are untouchable. Which means that between the two, Northrop Grumman would be the better buy. However, I believe there are better aerospace and defense stocks to buy than either of them.
Northrop Grumman has been the top-performing major defense stock over the past year, and at recent prices, trades at an industry-high 19.7 times earnings. And as discussed, its third-quarter earnings report left enough questions unanswered to raise concerns. Combine its sky-high valuation with the lingering uncertainty about the next few quarters, and Northrop has all the right ingredients to underperform its peers.
I don't believe the 737 MAX will permanently derail Boeing; nor do I believe Northrop Grumman has any structural issues that should raise concerns among long-term shareholders or prompt a selloff. But neither of these companies at the current time are top candidates to invest new money in.
