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Northrop Grumman Corp(NOC-N)

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Northrop Grumman Just Might Be the Best Space Stock to Buy

Motley Fool - Sun May 14, 6:07AM CDT

Easy come, easy go -- that's how one might describe Wall Street's reaction to Northrop Grumman's (NYSE: NOC) first-quarter earnings report.

Upon first consideration, investors reacted positively to Northrop's beating analyst consensus earnings on both the top and bottom lines. Northrop earned $5.50 per share on sales of $9.3 billion -- not the $5.09 on $9.2 billion that Wall Street had forecast. Northrop's stock price, accordingly, inched up 1% after earnings were announced and continued to drift higher the next day as well. Things quickly took a turn for the worse, however, and by the time markets closed for the week last Friday, Northrop had given up all its gains and was actually trading below what it cost before earnings came out: $446.81.

But should it have?

Northrop by the numbers

Admittedly, Northrop Grumman's Q1 financial results were far from uniformly great.

Despite beating analyst expectations, sales for the quarter grew only 6% year over year. Profits for the quarter actually declined 10%, with mission systems operating income down 6% year over year, and income at aeronautics systems -- once Northrop's biggest business -- down a staggering 23%. As Northrop management explained, lower profit margins within aeronautics, combined with lower production volumes of E-2 airborne early warning aircraft, F/A-18 fighter jets, Global Hawk drones, and F-35 stealth fighters, combined to tumble margins in the segment.

And yet, I'm not here to talk about the Northrop division that under-performed today. I'd rather talk about the division that wildly out-performed.

Northrop in space

Specifically, I want to talk about Northrop's relatively new space systems division, which has been leading the charge for the last several years -- and last year became Northrop's single biggest business with nearly $13 billion in annual revenue (according to data from S&P Global Market Intelligence).

As poorly as aeronautics performed last quarter, space performed that much better, growing its sales 17% year over year and growing its earnings by 20%. At $3.35 billion in Q1 sales, space is now 33% bigger than aeronautics at Northrop Grumman -- and at $313 million in operating earnings, it's the company's second-biggest profits producer.

Why not "first biggest?" Well, space's outperformance isn't making itself particularly well felt on the bottom line at present -- because profit margins at the new division are a lowly 9.3%. On the plus side, however, space grew that profit margin number last quarter, and indeed, space was the only division at Northrop to expand its profit margin. And if that trend continues even as space revenues grow, then over time, it's likely space could become a real profits driver for Northrop Grumman.

We're No. 1!

How did space become Northrop Grumman's most important business? In part, it's due to characterization.

Much of the revenue that Northrop Grumman classifies as "space" comes from stuff ordinary folks might instead consider "defense" (which is Northrop's smallest business segment) -- nuclear missiles and "interceptors" designed to shoot down incoming missiles. But space also includes such things as the Space Force's new tracking layer system of missile detection satellites and the upcoming system of Next-Generation Overhead Persistent Infrared Polar (NGP) missile detection satellites.

Northrop Space also gets revenue from its NASA contract for commercial resupply of the International Space Station and from contracts related to the Project Artemis return to the moon. But in the big picture, it's probably most accurate to say that a lot of the growth Northrop is seeing in "space" comes from building defense-related satellite constellations. So long as Northrop can continue winning business in this area and outmaneuvering mega defense rivals such as Lockheed Martin, the space business should do well.

Longer term, though, keep your eye on developments in the civilian sphere as Northrop continues to blaze new trails in commercial space, developing Mission Extension Vehicles and Mission Robotic Vehicles to repair, refuel, and tow civilian satellites in orbit. Competition in this new field of space business, which Northrop is essentially building from scratch, is much less fierce -- and until viable competitors emerge, it's likely the profit margins here will be much stronger and sales growth even faster.

At a valuation of only about 14 times earnings, Northrop Grumman stock may not look like a great bargain, with analysts forecasting only 4% growth rates over the next five years. By the same token, though, it wouldn't take much of an improvement in growth rates to turn this stock into a really great "buy."

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends Lockheed Martin. The Motley Fool has a disclosure policy.

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