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Navy Awards $1.3 Billion in Warship Contracts

By Rich Smith – Mar 27, 2016 at 12:13PM

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Three contracts, three companies -- and every one's a winner. But which of the three is the winningest stock?


The Ticonderoga-class guided missile cruiser USS Vella Gulf (CG 72). Image source: U.S. Navy.

April 1 is just around the corner, and if you're at all familiar with the workings of the U.S. federal government, you know what that means: Another fiscal quarter is coming to a close -- and anyone who wants to get their contracts signed, and their money spent, before the books close on the quarter, had better act fast.

Which is great news for three of the world's biggest defense contractors: General Dynamics (GD 0.29%) and Huntington Ingalls (HII -0.39%), and Britain's BAE Systems (BAES.Y 0.46%) as well.

The news
Last week was a big week at the U.S. Pentagon. With more than $5.7 billion contracts awarded over five days, the Pentagon spent at the rate of more than $1.1 billion a day. Yet on one day in particular -- March 16 -- one single contract eclipsed that average all on its own.

The award in question, worth $1.3 billion to the three companies that will share in it, came from the U.S. Navy. While the language is a bit dense, the contract appears to guarantee each of General Dynamics, Huntington Ingalls, and BAE Systems the right to maintain two classes of U.S. Navy warships, each, over the next five years. The precise allocation of classes hasn't yet been decided, but a total of six classes are up for grabs, including destroyer and cruiser surface combatants, and also LSDs, LPDs, LHAs, and LHDs (amphibious warfare vessels).

Follow the money
Who will get the most out of these contracts, and which of these three stocks will benefit the most? That depends on a couple of factors.

Clearly, the real moneymaker is going to be the surface warfare maintenance contracts -- and within that broad class, the destroyer contract will be more lucrative than the cruiser contract. According to the Navy's fleet register, there are 90 surface combatants in the fleet, versus just 30 amphibs. Furthermore, within the surface combatant fleet, 69 Arleigh Burke-class destroyers are either in service or under construction (plus three Zumwalt-class destroyers). Compared to that, the chance to maintain 22 cruisers is a much smaller opportunity.

Currently, we don't know which contractors will play mechanic to which warships. But here's what we do know:

 Metric

General Dynamics

BAE Systems

Huntington Ingalls

Market capitalization

$42.1 billion

$22.4 billion

$6.4 billion

Revenue

$31.5 billion

$23.8 billion

$7.0 billion

Net profit

$3 billion

$1.3 billion

$404 million

Dividend yield

2.2%

4.2%

1.4%

Data sources: Yahoo! Finance. S&P Global Market Intelligence.

Maritime work makes up about 25% of the revenues General Dynamics collects in a year, and about 28% of BAE's business. But Maritime is all Huntington Ingalls does. Assuming a roughly equal split in the amount of work awarded among the three companies, one-third of $1.3 billion in new maritime revenue will move the needle a whole lot farther at Huntington Ingalls than at General Dynamics or BAE Systems.

What's more, its intense focus on just one type of work helps Huntington Ingalls earn better profit margins from maritime work than its rivals get. Operating margins average 11% at Huntington, versus 9% and change at both General Dynamics' and BAE's maritime divisions. Applied to the $430 million or so that Huntington Ingalls might expect to win under this contract, the company can be expected to earn net profit of about $48 million.

Should you buy Huntington Ingalls stock?
That's a nice chunk of change for a company that earned "only" $404 million last year. But it's not the only reason to be optimistic about Huntington Ingalls stock. Take a look at how Huntington compares to its coworkers:

 Metric

General Dynamics

BAE Systems

Huntington Ingalls

Price-to-earnings ratio

14.1

17.2

16.1

Price-to-free cash flow

22.2

56.5

10.2

Price-to-sales

1.3

0.9

0.9

Projected 5-year growth rate

10.4%

5.6%

27.5 %

Data source: S&P Global Market Intelligence.

Valued in the middle of the pack on price-to-earnings, Huntington is the cheapest of the three stocks when valued on either price-to-sales or (especially) price-to-free cash flow. Huntington is also -- according to analysts polled on S&P Global Market Intelligence -- growing its business far faster than its rivals. And now that it's won a big piece of a huge Navy contract, you can see why.

Long story short, out of these three big naval contractors, Huntington Ingalls is clearly the stock I like best -- with or without this latest contract win, and definitely with it.

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. 288 out of more than 75,000 rated members. Follow him on Facebook for the latest in defense news.

The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

General Dynamics Stock Quote
General Dynamics
GD
$251.22 (0.29%) $0.73
BAE Systems plc Stock Quote
BAE Systems plc
BAES.Y
$39.09 (0.46%) $0.18
Huntington Ingalls Industries Stock Quote
Huntington Ingalls Industries
HII
$228.02 (-0.39%) $0.89

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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