Los Angeles-based defense contractor Northrop Grumman Corporation (NOC) is mulling over exiting the shipbuilding business. The company on October 15, 2010 filed a Form 10 registration statement with the U. S. Securities and Exchange Commission contemplating the exploration of strategic alternatives for its shipbuilding business.
Northrop Grumman’s shipbuilding business, headquartered in Newport News, Virginia, is the U.S.’s sole industrial designer, builder and refueler of nuclear-powered aircraft carriers. Northrop Grumman and General Dynamics Corporation (GD) are the only two companies capable of designing and building nuclear-powered submarines for the U.S. Navy.
The company is also one of the U.S.’s leading full service systems providers of design, engineering, construction and life cycle support for major programs for the surface ships of the U.S. Navy, U.S. Coast Guard and international navies.
Northrop Grumman’s exploration of various alternatives for the potential separation of its shipbuilding business is precipitated by tax considerations. In July 2010, the company announced plans to consolidate its shipbuilding operations by winding down its shipbuilding works at Avondale, Louisiana in 2013 after completing the existing ships under construction. The company aims to build all ships in a single production line at its Pascagoula, Mississippi facility.
Northrop Grumman is streamlining its shipbuilding activities to reduce costs, increase efficiency and reduce its shipbuilding overcapacity. However, the consolidation route looks unattractive as the company is estimating $210 million of higher costs. The company also recognized a $113 million pre-tax charge to Shipbuilding’s second quarter 2010 operating income for these contracts.
Northrop Grumman provides products, services and solutions in information and services, aerospace, electronics and shipbuilding to the military, government and commercial customers in the United States and beyond.
Northrop Grumman’s success in the competitive defense industry depends upon its ability to develop and market its defense-related products and services to the U.S. Government, as well as its ability to provide people, technologies, facilities, equipment and financial capacity needed to deliver those products and services at maximum efficiency.
We believe that Northrop Grumman is fundamentally a sound company and has a strong market position, but we are cautious about near-term bumps. The company currently is trading at a discount to both the peer group and the S&P 500, based on forward earnings estimates.
Northrop Grumman currently has a dividend yield of 3.04%. This is higher compared to other large cap defense companies like, Empresa Brasileira de Aeronáutica S.A. (ERJ) and The Boeing Company (BA) who have yields of 0.63% and 2.40%, respectively.
Northrop’s product line is well positioned in high priority categories, such as defense electronics, next-generation ships, unmanned aircraft and missile defense. Revenue and earnings growth continues to be driven by its strong presence in the current focus areas of cyber security, intelligence, surveillance and reconnaissance.
However, we believe all the above positives have already been taken into account. Over the past week, the stock was down approximately 0.7% attributable to a breather in the absence of any positive trigger. We believe the stock would move sideways in the near-term and retain a short-term (1 to 3 months) Zacks #3 Rank (Hold) on the stock. We are also maintaining our long-term Neutral recommendation on the stock.
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