HII Price Chart

Huntington Ingalls: This submarine-maker's stock is hitting new heights in the wake of a bang-up earnings report. HII Price data by YCharts.

Huntington Ingalls (NYSE: HII), America's premier builder of nuclear-powered warships, reported earnings for Q2 2015 this week. It blew estimates clean out of the water.

Expected to report Q2 revenues of $1.75 billion, and to earn about $103 million ($2.12 per share) in profits on those revenues, Huntington quite simply outdid itself. Matching analyst guesses on revenues, the company delivered profits that were 51% better than anyone dared hope for -- a whopping $3.20 in earnings per diluted share.

But how did they do that?

How they did that
If you ask CEO Mike Petters, Huntington Ingalls exceeded expectations last quarter through a combination of "persistent focus on program execution and risk retirement." This is a fair statement as far as it goes, even if it lacks a bit in details. So here are a few of those details for you.

Revenues in the fiscal second quarter eked out a 1.5% gain. That's not impressive in and of itself, but not a bad performance in the current environment of tight defense budgets for the Navy. Even more important to Huntington's bottom line, though, is what the company did with those revenues -- namely, earn a lot more profit on them.

Operating profit margins at Huntington Ingalls surged 490 basis points higher, to land at 15.4% for the quarter. That's nearly $0.05 more profit per dollar of revenue that Huntington earned in Q2 this year than it earned in Q2 last year.

What's next for Huntington Ingalls
Adding to the good news, Huntington says it brought in $4.5 billion in new contract awards during the quarter, resulting in a book-to-bill ratio of 2.6 for these three months. Those new contract wins expanded the company's backlog of work to be done -- i.e., future revenues -- to $24.3 billion. That's enough backlog to keep Huntington factories humming for the next three-and-a-half years straight, even if it wins not a single new contract award in that time.

Of course, Huntington is likely to win additional contracts. And analysts who follow the company see its stock growing its earnings at nearly 10% annually during the next five years. But does that make the stock a buy?

Maybe, maybe not.

The upshot for investors
You see, business is booming at Huntington Ingalls right now. But even so, with the stock now up 25% in the past year, the stock's current valuation ($5.9 billion) looks a little stretched relative to its trailing earnings of $391 million, according to S&P Capital IQ's most recent tally. That works out to about a 15.1 P/E ratio on the stock, which may seem a bit pricey for an anticipated 10% grower.

The good news, though, is that, despite the apparent overvaluation of Huntington's P/E ratio, the stock looks much more reasonably priced when you value the stock on the actual free cash flow it's producing. FCF for the past 12 months now amounts to $658 million, or 68% more than shows up on the income statement as "net income." And that means that, when valued on free cash flow, the stock is selling for just nine times FCF -- a very nice price to pay for a 10% grower.

Factor in Huntington's net debt load of about $345 million, and worst case, I see this stock selling for an enterprise value-to-free cash flow ratio of 9.5. Between the strong projected growth rate and the modest dividend yield of 1.4%, the very worst I can say about Huntington Ingalls stock today is that it might be only fairly priced. All things considered, though, I think it's actually looking pretty cheap.

Rich Smith does not own shares of, nor is he short, any company named above. You can find him on Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 338 out of more than 75,000 rated members.

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