Huntington Ingalls (NYSE:HII) loves to build aircraft carriers -- in all shapes and sizes.
At the large end of the scale, Huntington's Newport News division is America's only dedicated builder of nuclear-powered aircraft carriers such as the USS John C. Stennis (CVN 74), currently on tour in the South China Sea, and the new USS Gerald R. Ford (CVN-78). At the low end, Huntington's namesake Ingalls Shipbuilding division builds a wide variety of amphibious assault ships.
Designated either LPD, LHA, or LHD, depending on their specific form and function, Huntington's amphibious assault ships are basically mini aircraft carriers, capable of undertaking everything from disaster relief missions to offering air support for beach-assaulting Marines. Currently, Huntington Ingalls is in the final stages of wrapping up construction run of a dozen San Antonio-class LPD amphibious transport docks.
Two weeks ago, Huntington announced the official "delivery" of its 10th LPD, the USS John P. Murtha (LPD 26), to the U.S. Navy. Just this past Saturday, the company christened Murtha's sister ship the USS Portland (LPD 27). Once that one has undergone its sea trials, it is expected to be delivered next year.
And finally, wrapping up the trifecta, Huntington says it has received more than $300 million in funding from the Defense Department to build the final ship of the LPD class, the USS Fort Lauderdale (LPD 28). Ultimately, that one is expected to approximate $2 billion, with delivery probably in late 2021.
As you might expect, this huge spurt of LPD-building has had a beneficial business effect at Huntingon's Ingalls Shipbuilding division, where revenue shot up 25% last quarter. With construction work rolling like clockwork, profit margins at the division improved by nearly half, rising to 14%. Yet not all is well with Huntington Ingalls.
A storm is brewing, and nary a port in sight
Last quarter, Huntington Ingalls management took pains to warn investors that the great good fortune it's enjoyed on both revenue and profit margins will not last -- that in particular, operating profit margins that have been averaging 11% annually could slip to 10%, or even 9%, in the very near future. Here's why:
Murtha was just delivered, and Huntington expects to deliver Portland in 2017. Fort Lauderdale's construction, in contrast, was only just authorized by Congress, and delivery is not expected until five years from now. In the meantime, work on a new class of amphibious assault ship, currently designated simply "LX(R)," may (or may not) begin in 2020. And that leaves at least three long years in which Ingalls will be in a state of slowdown, its mini aircraft carrier work drying up, and its efficiencies of production beginning to erode.
Huntington has highlighted this "production gap between LPD 28 and [LX(R)]" as one of its key vulnerabilities over the next few years. According to management in its recent conference call, bridging the gap between ending work on Fort Lauderdale and beginning work on LX(R) "is critically important to maintain the efficiency and the effectiveness of" Ingalls Shipbuilding.
What does it mean to investors?
Huntington Ingalls is pressing the Navy to help it maintain production efficiency by either (1) ordering a 13th San Antonio-class LPD vessel, which Huntington could work on while awaiting approval of the next wave of LX(R) ships, or (2) moving up the schedule on LX(R) itself, authorizing work to begin in "either 2019 or 2018." Either alternative, says Huntington CEO Mike Petters, would "reduce the production gap between LPD 28 and LX(R) and leverage the benefits of hard production lines." Either would save taxpayers money, and not incidentally, probably save Huntington Ingalls' current robust profit margins.
Failing either option, on the other hand, gives rise to just one conclusion: Huntington Ingalls' profit margins are going down.
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. 299 out of more than 75,000 rated members.
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