Companies that receive billions of dollars of orders from the government have a good chance for success. And that’s how investors feel about Huntington Ingalls Industries (NYSE: HII).
HII, the country’s largest military shipbuilder, has seen its stock soar 53% over the past six months. The biggest factor behind that move was President Trump’s February order to promote the ship business. That means tax incentives for manufacturers and a new office of shipbuilding in the White House.
“The order appears to cement the administration’s focus on domestic maritime labor, supply chains, and production,” Goldman Sachs analyst Noah Poponak wrote in a commentary. “That could drive margin upside for Huntington.”
HII’s operating profit margin totaled 5.3% in the second quarter. That’s not very high. Huge profits aren’t in the equation for HII, but consistent profits are, and there’s something to be said for that. “We look for the durability of economic profits, not necessarily their magnitude,” wrote Morningstar analyst Nicolas Owens.
“While HII earns only a few points of profit above its cost of capital, we see those returns as unusually likely to persist well beyond 20 years.”
Plenty of defense needs
Given the geopolitical strife bubbling across the globe, it seems like there will be plenty of demand for the products HII makes. The U.S. budget bill passed in July increases defense spending by $150 billion for the next 10 years. “We expect Navy shipbuilding to be a high priority within the defense budget medium-term and for Huntington to benefit,” Poponak said.
HII is involved with almost every important military shipbuilding project. It is the only supplier in areas including aircraft carriers. Among defense products, ships have the longest life cycle. It takes years to make them, and they can remain in use for about 50 years, Owens notes. That means a long, steady revenue stream for HII.
The most important products for the company are nuclear-powered submarines and large surface warships. For now, aircraft carriers also are a strong segment or HII. But that may not last, as the navy seeks to cut the amount of its force that’s concentrated in just a few ships, Owens says.
HII’s most famous ships include USS Enterprise, the first nuclear-powered aircraft carrier; America-class amphibious assault ships; and Arleigh Burke-class destroyers.
Earnings numbers
HII’s revenue rose 3.5% in the second quarter from a year earlier to $3.1 billion, and profit fell 12% to $152 million. But profit can be volatile from quarter to quarter, as long-term government contracts make the company vulnerable to inflation, labor and supply chain issues. Small timing adjustment can wreak havoc on quarterly numbers, Owens noted. Second-quarter profit actually beat analysts’ forecasts.
Huntington’s production slowed in recent quarters because of difficulty in retaining skilled workers at its shipyards. But CEO Chris Kastner says that problem is easing, as are supply-chain issues. To be sure, on the supply chain side, “risk remains for some major equipment,” he said in the July earnings conference call.
Also, “the next 1 1/2 years will be challenging as we transition out of ships contracted for pre-Covid to our new contracts,” Kastner said.
So it’s not all smooth sailing for HII, but it has plenty of wind at its back.
The author owns shares of Hunter Ingalls.
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