The earnings are out and the numbers are in -- and Huntington Ingalls (NYSE:HII) is more profitable than ever. On May 5, Huntington Ingalls, the nation's foremost builder of nuclear warships such as aircraft supercarriers and fast attack submarines, announced a 12% surge in quarterly sales leading to a stunning 60% gain in quarterly profits.
But not all the news at Huntington Ingalls is good. In fact, as management revealed to investors listening in on its post-earnings conference call, the good times are almost certain not to last forever.
In our continuing effort here at The Motley Fool to keep you up to date on what Huntington reveals to the analysts participating in its earnings call, we listened in. Here are five things we thought you'd like to know.
Thing 1: Profit margins may vary
We've been talking for five years about [how a] healthy shipbuilding business has a blend of programs that will keep it in the 9% range to 10% range. ... We've worked really hard over really the last eight years to get Ingalls into a serial production mode [and] to drive high returns in mature programs. ... [O]ur shipbuilding business will be in the 9% to 10% range [long-term, and] I think that's pretty predictable over the next -- out to 2020.
That's the first quote we'll pull from Huntington Ingalls CEO Michael Petters today (and all the others are from Petters, as well). We're highlighting this one right up top, though, because it's arguably the most important fact to keep in mind.
Huntington Ingalls scored an 11.2% operating profit margin last quarter, and really, its profit margins have been above average for about the past 18 months. But it's crucial to understand that Huntington itself expects profit margins to return to average, eventually. That average is "9% to 10%," and it implies as much as a 20% drop in annual profits, per revenue dollar, eventually. Be prepared.
Thing 2: The submarines are coming
The Navy ... specified that Newport News will build sections of [the Ohio Replacement SSBN] consistent with the sections they build on the [Virginia-class submarines] program. At the same time, Newport News will perform additional final assembly testing and delivery work on [Virginia-class submarines]. We are pleased with this outcome ...
Not all the extra information Huntington Ingalls discussed in its conference call was bad. This bit is particularly good. Huntington Ingalls' position as one of two key builders of Virginia-class nuclear-attack submarines is secure. Plus, the Navy has confirmed that it will split the revenue on Ohio Replacement-class nuclear-ballistic-missile submarines with its archrival General Dynamics (NYSE:GD).
The first Ohio Replacement alone is expected to cost almost as much as an aircraft carrier -- $13 billion. So even sharing the wealth with General Dynamics, Huntington Ingalls stands to make bank on this program.
Thing 3: Even good news isn't all good
I've said for a while now that the number one issue facing the industry is how does Ohio replacement program [get] funded without squeezing out other programs. The Congress and the Navy are trying to work through a funding mechanism ... [but] I do not know how that happens.
That's the downside of building $13 billion submarines. Before Huntington Ingalls and General Dynamics can build them, Congress has to find a way to pay for them. Petters readily admits that, when he looks at the Navy's anticipated budget during the next few years, it's not at all clear where the money will come from.
Complicating matters further, at the same time as the Navy begins construction of Ohio Replacement SSBNs, the Navy also needs to continue replacing -- and paying to replace -- aging attack submarines. If the Navy is forced to scavenge funds from one program to pay for the other, this will not be good news for Huntington Ingalls, which depends on the construction of both classes of submarines to keep its revenue stream flowing.
Thing 4: A hiccup in the carrier program
At Newport News, CVN-78 Ford experienced some challenges in the test program that resulted in a delay of builder's trials. While we [were] a bit disappointed with this outcome, the challenges are not out of the ordinary for the lead ship of a class. ... [Regardless] the ship will go to sea this summer, and we are targeting a delivery in September or so.
Huntington Ingalls could see some revenue pushed back due to this delay. That could imperil analyst forecasts for Q2 revenue -- but the revenue will arrive eventually, as will the Navy's newest supercarrier. "September or so" gives Huntington plenty of leeway to ensure that this small hiccup in the Ford's path to delivery will not imperil full-year revenues, for which analysts are targeting $7.09 billion.
Thing 5: Arctic gold?
The Coast Guard is talking about an icebreaker program. We're very interested in that program, and have been working to understand more what their requirements are. And as we move down that path, it's kind [of] on the very front end of the program at this point. The Coast Guard is talking to the industry about what's the art of the possible.
Final point. We've written several times now on the subject of the U.S. Coast Guard's desire to greatly increase the size of its icebreaker fleet. Currently, the Coast Guard has a grand total of two icebreakers, both pretty old. To put that in context, Russia, which is racing with the U.S. to open up new shipping lanes, and drill for oil in a melting Arctic Ocean, boasts 42 icebreakers, and has 14 more on order.
It appears that Huntington Ingalls has been following this story avidly as well. But as this comment from Petters makes clear, the U.S. government has come to no firm conclusion on its plans to expand the icebreaker fleet -- or pay for such an expansion.
For the time being, we're all in the same boat with Huntington Ingalls, waiting to see which way the wind will start blowing. As soon as we know more, though, rest assured -- we'll share it with our readers.