Defense contractor Northrop Grumman (NYSE:NOC) reported earnings Thursday morning. As you can tell from the stock price (up 2.9% as of this moment), the news was pretty good. But exactly how good was it?
Well, let's see here. In 2014, Northrop Grumman reported that:
- Sales shrank by nearly 3%.
- But operating profit margins expanded by 60 basis points, reaching 13.3%. Consequently, both operating and net profits grew slightly despite weaker sales.
- Net profits were $2.1 billion, up 6% year over year.
- Meanwhile, profits per diluted share grew 17%.
Yes, that's right -- and 17% is the first important number you need to know about Northrop. Even in an era of stagnant defense spending and negative sales growth for Northrop, the company nonetheless managed to grow its earnings per share in the strong double digits.
How it did that leads us directly into our second important number needed to understand Northrop: 9%. That's the amount by which Northrop shrank its share count last year, buying back shares so that its profits "pie" got sliced up into fewer "pieces" per shareholder.
Beginning the fiscal year with 233.9 million being its weighted average number of diluted shares outstanding, Northrop spent hand over fist until it had bought back enough shares to end with a weighted average of 212.1 million -- a more than 9% drop. Divided among those fewer shares, Northrop's net profit of $2.1 billion worked out to each share earning $9.75 in profit -- beating analyst estimates handily.
Bonus prize: One more number worth knowing
Now, before we sign off for today, there is one more number that you should probably know about Northrop Grumman. And it's one that should concern you, because it directly affects the company's ability to continue buying back shares, and growing its profits in the absence of sales growth. This number is the amount of free cash flow that Northrop generated last year: $2 billion.
You'll notice first of all that $2 billion is less than the $2.1 billion in "net profit" that Northrop reported for the year. You may also notice that, when divided into the company's $31.5 billion market capitalization, it works out to a price-to-free-cash-flow ratio of 17.5 on Northrop Grumman stock. That's a bit on the high side for a stock that pays its shareholders a dividend yield of less than 2%, and that is expected to post long-term earnings growth of barely 9%. Consider further how much debt Northrop Grumman has taken on in furtherance of its stock buyback scheme -- enough that the company now carries $2.5 billion more debt than cash on its balance sheet. That means the stock is even more expensive than its market cap makes it look.
Long story short, while I'm as pleased as anyone else to see Northrop Grumman growing earnings nicely in a slow-to-no-sales growth environment, I'm less than thrilled with the stock's valuation. I also can't help but worry that, with free cash flow shrinking alongside sales, Northrop Grumman may soon find it difficult to keep GAAP "earnings" growing through stock buybacks.
In short: Good as Northrop's news was today, I'm not at all certain the company's worth the bump in share price that investors gave it.