"Building these warships on a regular schedule ensures stability in construction, keeps production lines active and allows ... suppliers to allocate their resources and manpower to support the cost-effective and fiscally efficient production of amphibious warships. ... It is ... critical to national security that the U.S. industrial base that provides parts and products for amphibious warships remain strong."
-- The Amphibious Warship Industrial Base Coalition
Chalk up another win for the lobbyists -- and get ready to write a $4 billion check, Mr. and Mrs. Taxpayer. Because the U.S. Navy is about to get two new warships -- that it didn't even ask for.
On Dec. 4, military shipbuilder Huntington Ingalls (NYSE:HII) won a $200 million award to begin purchases of long-lead parts needed to build a new San Antonio-class amphibious transport dock, to be designated "LPD 28." The "undefinitized" award, whose ultimate cost remains to be seen, is likely to rise as high as $2 billion over the course of the warship's construction, the Navy has said. And because of a quirk in how the Navy builds its ships, that won't be the end of the spending.
Under the terms of a 13-year-old agreement among the Navy, Huntington Ingalls, and rival shipbuilder General Dynamics (NYSE:GD), whenever one of these contractors wins a shipbuilding contract, the Navy awards another contract of roughly equal value to its rival. Construction of LPD 28 will round out the originally planned fleet of 12 San Antonio-class ships that the Navy had envisioned, however. So instead of an LPD, the Navy has elected to award a contract to General Dynamics to build another Arleigh Burke-class destroyer -- valued roughly equally at $1.9 billion -- instead.
(This destroyer contract, however, has yet to be authorized and funded by Congress).
Why this is a surprise
Curiously, LPD 28 is a ship the Navy had already probably resigned itself to never getting. As far back as March 2014, the Navy knew that tight budgetary times were causing Congress to cut short the San Antonio-class shipbuilding line at 11 vessels. Huntington Ingalls (and its lobbyists -- see the preceding quote) weren't exactly thrilled about this, but according to DefenseNews.com, the Navy had already moved on, and wasn't expecting to get its 12th LPD in any case.
For its part, the extra DDG probably came as just as much of a surprise for General Dynamics, being awarded as it was "in addition to the currently contracted multiyear ships."
What it means to shareholders
In a word, and a number, this news probably means "$2 billion" in extra windfall revenue for Huntington Ingalls and General Dynamics. But while the dollar values are roughly equal, the value to the companies, and their shareholders, weighs heavily in Huntington's favor -- and for two reasons.
Firstly, according to data from S&P Capital IQ, $2 billion is about 28.5% of Huntington Ingalls' annual revenue, a very nice boost to the business. Shipbuilding produces a similar dollar value for General Dynamics (about $7.3 billion annually), but shipbuilding is just one of four major businesses at General Dynamics, meaning that a contract that will weigh heavily in Huntington's favor won't move the needle quite as much at General D.
Compounding the benefit to Huntington is that its Ingalls shipbuilding division earns 10% operating profits on revenue, which eclipses the 9.6% margin General Dynamics earns from shipbuilding work. In short, therefore, while these contracts are good news for General Dynamics, they're even better news for Huntington Ingalls.
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. 308 out of more than 75,000 rated members.
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