Huntington Ingalls Stock Slumps Despite Strong Earnings

By Markets Fool.com


It's earnings season for defense contractors on Wall Street. Today, we take a look at how Huntington Ingalls fared. Image source: Getty Images.

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Military shipbuilder Huntington Ingalls Industries (NYSE: HII) closed out a week of strong earnings by defense companies last week with a bit of a mixed message. According to analyst reports, the company missed slightly on its revenue number (collecting an even $1.7 billion, when $1.72 billion had been forecast), but beat on earnings, delivering a penny more than analysts' $2.31 pro forma estimate.

So was this good news, or bad news?

Q2 by the numbers

Let's start with the high-level numbers. In Q2 2016, Huntington Ingalls reported:

  • Quarterly sales of $1.7 billion, down 3% year over year -- in line with the decline that rival General Dynamicsalso reported last week.
  • Profit margin likewise dropped year over year. In Q2 2015, a favorable insurance litigation settlement boosted operating margin to an extraordinarily high 15.4%. Without that tailwind in Q2 2016, the margin dropped to (a still historically strong) 12.8%.
  • When all was said and done, earnings per share dropped 12% to $2.80 -- down year over year, but ahead of estimates.

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Moving now to the company's two main segments... Huntington's flagship Newport News Shipbuilding division is the company's largest by a factor of two, but also its least profitable -- two gaps that both closed a bit in the quarter. Revenue at Newport News dropped 6.5%, while profitability increased modestly as operating margin inched up from 9.3% a year ago to 9.4% in Q2 2016.

In contrast, Huntington's smaller but more profitable Ingalls Shipbuilding division saw revenue grow 7% (offsetting the decline at Newport News somewhat). Profitability here is trickier, due to the one-time benefit from the litigation settlement mentioned above. But pro forma at least, operating profit margin appears to have grown nicely, rising from 11.1% a year ago to 15% today.

The rest of the year

Overall, that sounds like pretty good news. Back out the effects of the one-time benefit, and profit margin grew at both main divisions. Revenuealso grew at the more profitable Ingalls unit, offset only by a decline in lower margin revenue at Newport News. CEO Mike Petters called these results "solid," and I agree.

That said, the CEO did warn that Huntington's "second half will be challenging." This foreshadowing, combined with the lack of guidance on full-year revenue and earnings, may be what spooked investors and helps explain the decline in Huntington Ingalls' stock. Management's allusion to potential problems with getting its new aircraft carrier, USS Gerald R. Ford(CVN 78), ready for "sea trials and delivery" later this year probably exacerbated the stock's decline, as it appears to confirm worries voiced by defense stock analysts earlier this summer.

Valuation

So where does this leave investors today? Valued at $8 billion, Huntington Ingalls stock sells for about 18.5 times earnings and 1.1 times sales -- both numbers look "expensive" historically. On the other hand, profit margins are still rising, sales look relatively stable, and analysts who follow the stock still tell S&P Global Market Intelligence they expect to see 27.5% long-term annual earnings growth out of Huntington Ingalls.

I have to say, while the valuation looks expensive, the analysts' growth estimates do have me intrigued. Twenty-ish percent growth is not a number you often see posited for old guard, industrial companies -- much less industrial defense contractors operating in a constrained spending environment. If Huntington Ingalls can "hit those numbers," Huntington's stock price may not be as expensive as it seems.

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Rich Smithdoes not own shares of, nor is he short, any company named above. You can find him onMotley Fool CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 308 out of more than 75,000 rated members.

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