Northrop Grumman (NYSE: NOC)
QVI Updated Research Report | August 2023 | Rating Change
Summary
Northrop Grumman is an entrenched member of the military-industrial complex and has the long-term benefits of predictable if incremental, growth and steady profit margins leading to broader market outperformance.
In early to mid-2022, Northrop Grumman caught QVI’s attention for its superior business model and share price performance compared to its peers in a bear market Seeking Alpha article.
Despite a wide-moated value proposition, high-quality business model, and below-average downside risks, operating and free cash flow metrics remain below QVI’s threshold and send caution to the wind.
Thus, this updated research report has downgraded Northrop Grumman’s rating in the Expanded Portfolio on valuation concerns.
When referencing this report, premium (paying) subscribers can access their Quality Value Investing (QVI) Glossary of Investing Terms and Metric Targets. Unless noted, all data presented is sourced from Seeking Alpha Premium as of the market close on July 31, 2023, and intended for illustration only. If reading this in your email, consider viewing in the Substack App for a more inclusive experience.
Northrop Grumman Value Proposition
QVI Research Report’s value proposition section provides a brief synopsis of the company’s business model, major-exchange listing, stock symbol, market capitalization, and dividend-paying status. In addition, it defines the competitive advantages of a company’s products or services to its customers compared to the industry, including the stock’s historical performance vs. the sector and market.
Northrop Grumman Corporation NOC 0.00%↑ is a dividend-paying large-cap stock in the industrials sector’s aerospace and defense industry. NOC was added to the QVI Expanded Portfolio on March 25, 2022, at a split and dividend-adjusted $449.79 a share.
Northrop Grumman Corporation operates as an aerospace and defense company worldwide.
The Aeronautics Systems segment designs, develops, manufactures, integrates, and sustains aircraft systems in the United States and internationally. This segment also offers unmanned autonomous aircraft systems, including high-altitude long-endurance strategic ISR systems and vertical take-off and landing tactical ISR systems; strategic long-range strike aircraft, tactical fighter and air dominance aircraft, and airborne battle management and command and control systems.
Its Defense Systems segment designs, develops, and produces weapons and mission systems. It offers products and services, such as integrated battle management systems, weapons systems and aircraft, and mission systems. This segment also provides command and control and weapons systems, including munitions and missiles; precision strike weapons; propulsion, such as air-breathing and hypersonic systems; gun systems and precision munitions; life cycle service and support for software, weapons systems, and aircraft; and logistics support, sustainment, operation, and modernization for air, sea, and ground systems.
The company’s Mission Systems segment offers cyber, command, control, communications and computers, intelligence, surveillance, and reconnaissance systems; radar, electro-optical/infrared and acoustic sensors; electronic warfare systems; advanced communications and network systems; cyber solutions; intelligence processing systems; navigation; and maritime power, propulsion, and payload launch systems. This segment also provides airborne multifunction sensors; maritime/land systems and sensors; navigation, targeting, and survivability solutions; and networked information solutions.
Its Space Systems segment offers satellites and payloads; ground systems; missile defense systems and interceptors; launch vehicles and related propulsion systems; and strategic missiles.
Northrup Grumman was founded in 1939 and is based in Falls Church, Virginia, USA.
QVI’s value proposition elevator pitch for Northrop Grumman:
Elections, periods of peacetime, and budget limitations notwithstanding, being an entrenched member of the military-industrial complex has the long-term benefits of predictable incremental growth and steady profit margins leading to broader market outperformance.
Performance vs. Sector and Market
The chart below illustrates NOC’s performance against the Industrial Select Sector SPDR® Fund ETF (NYSE: XLI) and the SPDR® S&P 500 ETF Trust (NYSE: SPY) for the trailing 10-years, including QVI’s initial coverage period of Northrop Grumman in March 2022.
For example, despite outperforming in 2022, NOC was cumulatively flat to the S&P 500 during the QVI coverage timeframe. However, it enjoyed a 10-year trailing history of trouncing its sector and the broader market in total return.
Due Diligence Resources
For a more in-depth analysis of the all-important value proposition, visit Northrop Grumman’s investor relations webpage and its most recent Form 10-K Annual Report submitted to the US Securities and Exchange Commission or SEC.
QVI’s value proposition rating for Northrop Grumman: Bullish.
NOC Total Return vs. XLI and SPY
Northrop Grumman Corp (NOC) Total Return: +486.40%
Industrial Sel Sec SPDR ETF (XLI) Total Return: +196.00%
SPDR S&P 500 ETF Trust (SPY) Total Return: +225.90%
Ten-Year Trailing (as of July 31, 2023)NOC Shareholder Yields
QVI Research Report’s shareholder yields section uncovers the equity bond rate of the company’s common shares. It aims to quantify the yields on earnings, free cash flow, and dividends to measure how the targeted stock compares to the prevailing yield on the 10-Year Treasury benchmark note.
Earnings and Free Cash Flow Yields
NOC’s earnings yield traded above the QVI targeted floor at 6.77%, as demonstrated in the below chart. On the contrary, at 3.30%, NOC’s free cash flow yield traded under the threshold.
As inverse valuation multiples, the weighted earnings and free cash flow yields suggest that NOC now trades at fair market value. QVI will further explore valuation multiples later in this report.
Dividend Yield
Northrop Grumman offers a modest forward dividend yield of 1.59%, supported by a conservative 29.14% payout ratio, thus indicating a dividend rate with room for additional annual increases.
NOC yielded 1.66% from an annual payout of $7.48 on a split- and dividend-adjusted cost basis of $449.79 per share on March 25, 2022, the date of QVI’s initial stock coverage. Thus, our yield-on-cost basis was +7 bps above the forward yield.
Average of Shareholder Yields
Quality Value Investing takes the average of the three shareholder yields to measure how the stock compares to the prevailing yield of 3.97% on the 10-Year Treasury benchmark note. For example, the average shareholder yield for NOC was 3.89% or -8 bps below the 10-Year and 3.91% or -6 bps below the Treasury yield when using QVI’s March 2022 yield-on-cost basis.
QVI’s shareholder yields rating for NOC: Neutral.
NOC Shareholder Yields
Northrop Grumman Corp (NOC) Price: $444.98
Northrop Grumman Corp (NOC) Earnings Yield: 6.77%
Northrop Grumman Corp (NOC) Free Cash Flow Yield: 3.30%
Northrop Grumman Corp (NOC) Dividend Yield: 1.59%
One-Year Trailing (as of July 31, 2023)Northrop Grumman Fundamentals
QVI Research Report’s fundamentals section measures the performance strength of the company’s senior management by analyzing revenue growth, net profit margin, and returns on equity and invested capital.
Revenue Growth and Net Profit Margin
Per the chart below, Northrop Grumman had positive three-year annualized low single-digit revenue growth of 2.65%, underperforming the 10.60% median growth of the industrials sector.
Farther down the income statement, Northrop Grumman had a trailing three-year double-digit net profit margin of 12.65%, doubling the sector’s median net margin of 6.31%
Returns on Equity and Invested Capital
Northrop Grumman’s management produced a trailing three-year return on equity or ROE of 42.53%, far surpassing the targeted threshold and the sector’s median ROE of 13.62%
Stock buyback programs often elevate ROE. For example, Northrop Grumman’s board of directors authorized a $500 million accelerated repurchase agreement in February. However, are they buying the stock at a discount for shareholders?
At 18.26%, Northrop Grumman’s three-year return on invested capital, or ROIC, was above the QVI threshold and outperformed the sector’s median ROIC of 7.01%, indicating that its senior executives are outstanding capital allocators.
In addition, Northrop Grumman’s ROIC doubles its already reduced weighted average cost of capital, or WACC, of 5.19%. (Source of WACC: GuruFocus).
Positive revenue growth, a double-digit profit margin, and sector-beating returns on equity and invested capital suggest that Northrop Grumman’s management continues its long history of 2nd level performance in Northern Virginia.
QVI’s fundamentals rating for Northrop Grumman: Bullish.
NOC Returns on Management
Northrop Grumman Corp (NOC) Revenue (3y Growth): 2.65%
Northrop Grumman Corp (NOC) Profit Margin (3y Median): 12.65%
Northrop Grumman Corp (NOC) ROE (3y Median): 42.53%
Northrop Grumman Corp (NOC) ROIC (3y Median): 18.26%
Three-Year Trailing (as of July 31, 2023)NOC Valuation, Risks, and Investment Thesis
Next, QVI dives into the valuation multiples, downside risks, and overall investment thesis of Northrop Grumman Corp. (NOC), including potential catalysts. So, let’s dig further after reading the required disclosures and background information.
Disclosure: I/we have no beneficial position through direct ownership of any stock mentioned in this report. I wrote this report myself, and it expresses my own opinions. I am not receiving compensation for it other than from Substack paid subscriptions. I have no business relationship with any company whose stock is mentioned in this article.
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About the Writer
David J. Waldron is the contributing editor of Quality Value Investing, and author of the international-selling book Build Wealth with Common Stocks: Market-Beating Strategies for the Individual Investor. David’s mission is to inspire the achievement of his readers’ financial goals and dreams. His work has been featured on Seeking Alpha, TalkMarkets, ValueWalk, MSN Money, Yahoo Finance, QAV (Australia’s #1 Value Investing Podcast), Money Life with Chuck Jaffe, The Acquirer’s Multiple, Amazon.com, Barnes & Noble, Apple Books, the BookLife Prize, and Publisher’s Weekly. David received a Bachelor of Science in business studies as a Garden State Scholar at Stockton University and completed The Practice of Management Program at Brown University.
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