Thursday, January 16, 2020

Northrop Grumman (NOC) Dividend Stock Analysis

Northrop Grumman Corporation (NOC) operates as a security company. It provides various systems, products, and solutions in autonomous systems, cyber, space, strike, and logistics and modernization, as well as in command, control, communications and computers, intelligence, surveillance, and reconnaissance (C4ISR) to customers worldwide. The company operates Aerospace Systems, Innovation Systems, Mission Systems, and Technology Services segments.

Northrop Grumman is a dividend achiever with a 16 year track record of annual dividend increases.

The last dividend increase happened in May 2019, when the Board of Directors approved a 10% hike to its quarterly dividend to $1.32/share.

During the past decade, the company has managed to increase distributions at an annualized rate of 12.70%.

Between 2009 and 2018, the company has managed to grow its earnings from $5.21/share to $18.49/share. The company is expected to generate $20.35/share in 2019.

Long-term growth will be closely tied to defense spending by its largest customer – the US government. The US government accounts for 82% of revenues. While there will be short-term hiccups along the way, I believe that defense spending should only increase in the long-term. The world is going to continue to be a hostile place, and increased spending may be necessary to maintain peace and manage conflicts. Aging military equipment needs replacement and/or repair with the potential for an upgrade. A lot of contracts are provided after competitive bidding, which is why it is a good idea to spread my defense company bets, rather than have all my eggs in one basket.

Growth could also be derived from strategic acquisitions, which could be bolt-on ones or in areas with higher expected growth. A good example of the latter is the acquisition of Orbital-ATK in 2018, which brings in higher growth potential.

Demand for its strategic programs could lead to increased revenues down the road, notably the B-21 bomber and the subcontracting work on Lockheed Martin’s F-35 system. Unique expertise in certain defense areas (e.g. fighter aircraft radars) could be lucrative for Northrop when it comes to winning contracts, and earning solid margins on them.

The Information Systems segment could deliver above average growth due to the long-term trends around increased demand on cybersecurity and intelligence systems.

Earnings growth due to share repurchases will be more muted over the next decade, given the much higher valuations than those at the beginning of the decade.

The tax cut from 2017 drove earnings per share growth in 2018, given the decrease in tax rates for corporations. A rise in tax rates by the middle of next decade could hurt earnings per share.

The massive growth in earnings per share has been helped by share buybacks, as Northrop Grumman has been very active on this front. Between 2009 and 2019, the number of shares outstanding has declined from 323 million to 171 million. Share buybacks had a better chance or reducing the number of shares outstanding quickly when the P/E ratios were lower at the beginning of the decade. During the latter part of the decade, with valuations increasing, it is getting harder to get the same result in share count reduction and corresponding EPS increase. Share price declines are good for share buybacks.

Between 2009 and 2019, the dividend payout ratio has decreased from 32% to 25%. The company has largely managed its dividend payout ratio in a tight range between 24% and 32% of earnings.

I find the stock to be fairly valued at 18.70 times forward earnings. The yield is a little low at 1.40% today, but the distribution is expected to grow at a higher rate.

I invested in the stock in late December through my premium Newsletter, in order to diversify my defense contractor exposure. That was before the events at the beginning of the year resulted in take-off for all defense companies. I may add to other defense contractors going forward, subject to availability of funds and subject to good valuations.

If the stock is available at better entry valuations, that would only increase forward returns of course. I would not chase the stock higher however.

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