Company Reports

Wide-moat Huntington Ingalls’ shares are trading 20% below our $317 fair value estimate. While shipbuilding doesn't offer the juiciest margins in the defense industry, it represents the quintessential set of conditions we see as providing durable competitive advantage and decades of visibility into revenue and profitability. The firm's quarterly revenue and profits can be lumpy, but we believe long-term investors will be rewarded in the wake of growing submarine and destroyer revenue.

Huntington Ingalls turned in first-quarter 2024 results that basically met our revenue forecast and slightly exceeded our conservative margin expectations. Management affirmed its expectations for 2024. We have increased our fair value estimate from $290 to $317 because we increased our near-term margin forecast based on these latest results, and we also trimmed our long term estimate of working capital needs at the company, both of which benefit cash flows.

Regulated margins, mature markets, customer-paid research and development, and long-term revenue visibility allow defense contractors to deliver a lot of cash to shareholders, which makes up for slow growth in this industry. Defense budgets usually ebb and flow with a nation's wealth and its perception of danger: in the U.S. and among its allies both have been on the rise, and geopolitics is leading to larger military budgets than we've seen for decades. For perspective, we estimate that the portions of the U.S. defense budget relevant to Huntington Ingalls and its peers shrank in 2012-17 by 2.6% while they grew in 2018-23 by 6.5%, annualized. We think the contracting budget will continue to grow, but more moderately, averaging around 2.5%-3.0% over the next five years.

We are reviewing President Joe Biden's fiscal 2025 defense budget request, released March 11, which is limited by a compromise struck in mid-2023 to avoid government shutdown at only a 1% increase over the 2024 sum.

Regulated margins, mature markets, customer-paid research and development, and long-term revenue visibility allow defense contractors to deliver a lot of cash to shareholders, which makes up for slow growth in this industry. Defense budgets usually ebb and flow with a nation's wealth and its perception of danger: in the U.S. and among its allies both have been on the rise, and geopolitics is leading to larger military budgets than we've seen for decades. For perspective, we estimate that the portions of the U.S. defense budget relevant to Huntington Ingalls and its peers shrank in 2012-17 by 2.6% while they grew in 2018-23 by 6.5%, annualized. We think the contracting budget will continue to grow, but more moderately, averaging around 2.5%-3.0% over the next five years.

Huntington Ingalls turned in final 2023 results that slightly exceeded our forecast and the company's prior expectations. Our overall forecast remains unchanged, and management provided its expectations for 2024. We have increased our fair value estimate from $285 to $290 mostly due to the company's longer-term cash flows coming closer into view.

Regulated margins, mature markets, customer-paid research and development, and long-term revenue visibility allow defense contractors to deliver a lot of cash to shareholders, which makes up for slow growth in this industry. Defense budgets usually ebb and flow with a nation's wealth and its perception of danger: in the U.S. and among its allies both have been on the rise, and geopolitics is leading to larger military budgets than we've seen for decades. For perspective, we estimate that the portions of the U.S. defense budget relevant to Huntington Ingalls and its peers shrank in 2011-16 by 3.7% while they grew in 2016-21 by 6.5%, annualized. We think the contracting budget will continue to grow, but more moderately, averaging around 2.5%-3.0% over the next five years.

Huntington Ingalls turned in third-quarter results largely in line with our expectations, and revised its expectations for the rest of 2023 slightly upward, meeting our previous forecast. We have revised our fair value estimate up to $285 from $283 to reflect the time value of the cash flows the company is accruing.

We see Oct. 9, 2023's sudden price increase in defense stocks as an overblown and simplistic reaction to the outbreak of war in Israel and Gaza. As we have pointed out before, the dots between military combat and the profit of a defense contractor do not connect nearly as directly as they seem to in the investing public's imagination. We will not alter our ratings or valuations of defense contractors in light of this news, and we believe long term development and resupply of missile defense technology are already baked sufficiently into our forecasts.

We are picking up coverage of Huntington Ingalls with a wide moat rating, and compared with our fair value estimate of $283 per share, we see the stock as undervalued. While the long-cycle shipbuilding business does not offer the juiciest margins in the defense contracting industry, it represents perhaps the quintessential set of conditions that we see as providing durable competitive advantage and extreme visibility into revenue and profitability for decades.

Regulated margins, mature markets, customer-paid research and development, and long-term revenue visibility allow defense contractors to deliver a lot of cash to shareholders, which makes up for slow growth in this industry. Defense budgets usually ebb and flow with a nation's wealth and its perception of danger: in the U.S. and among its allies both have been on the rise, and geopolitics is leading to larger military budgets than we've seen for decades. For perspective, we estimate that the portions of the U.S. defense budget relevant to Huntington Ingalls and its peers shrank in 2011-16 by 3.7% while they grew in 2016-21 by 6.5%, annualized. We think the contracting budget will continue to grow, but more moderately, averaging around 2.5%-3.0% over the next five years.

We are dropping coverage of Huntington Ingalls. We provide broad coverage of more than 1,500 companies globally and periodically adjust our coverage according to investor interest and staffing.

Huntington Ingalls Industries is the largest independent military shipbuilder and generates revenue on almost every military shipbuilding contract. Ships are the longest cycle defense product, as each ship takes years to manufacture and ships are typically purchased in blocks to reduce unit costs. The extended time required to build a ship means that funding for a project is difficult to cut and block purchases give contractors substantial visibility into the progression of revenue. Huntington Ingalls’ top line is, therefore, less sensitive to changes in the defense budget than peer contractors, making it a more defensive play among contractors.

Narrow-moat-rated Huntington Ingalls posted solid revenue growth and announced a significant share repurchase plan during the second quarter. Revenue of $2.7 billion and earnings per share of $4.44 beat FactSet consensus estimates by 1.2% and 31.8%, respectively. We are increasing our fair value estimate for Huntington Ingalls to $226 per share from $223 due to the time value of money.

Narrow-moat-rated Huntington Ingalls posted a steady first quarter as supplies are confirmed through long-dated contracts and demand is known years in advance. Sales of $2.6 billion and earnings per share of $3.50 beat FactSet consensus estimates by 2.1% and 8.8%, respectively.

Huntington Ingalls Industries is the largest independent military shipbuilder and generates revenue on almost every military shipbuilding contract. Ships are the longest cycle defense product, as each ship takes years to manufacture and ships are typically purchased in blocks to reduce unit costs. The extended time required to build a ship means that funding for a project is difficult to cut and block purchases give contractors substantial visibility into the progression of revenue. Huntington Ingalls’ top line is, therefore, less sensitive to changes in the defense budget than peer contractors, making it a more defensive play among contractors.

As the Russian military is conducting significant military operations throughout Ukraine, we believe it is worthwhile to reconsider the effects of the war on global defense budgets and the subsequent effects on defense prime contractor valuations. As of Feb. 28, the German Chancellor Olaf Scholz announced that Germany would increase defense spending from roughly 1.5% of GDP to over 2% of GDP and the Japanese Ministry of Defense announced in November that Japan’s fiscal 2022 defense budget would rise to about 1.14% of GDP, which would be the first time since the 1960s that Japanese defense spending exceeded 1% of GDP. Despite the increases in defense budgets, we are maintaining our valuations across our North American prime contractor coverage as we await news from Washington on defense spending for fiscal 2023. This noted, we would expect that the military operations will encourage more spending that would buoy the justified valuations of prime contractors, so we think the risks to our valuations skew to the upside. Valuation-wise, our preferred names within our defense prime coverage are Lockheed Martin and Huntington Ingalls.

Narrow-moat rated Huntington Ingalls Industries posted a decent fourth quarter as the firm laps a difficult comparable quarter in 2020. Sales of $2.7 billion beat FactSet consensus by 0.9%, but earnings per share of $2.99 missed the same estimates by 1.4%. After incorporating fourth-quarter earnings into our model, we are increasing our fair value estimate for Huntington Ingalls to $214 per share from $195, primarily due to our assumption that corporate tax increases will not occur, though this effect was partially offset by higher assumed working capital and the capitalization of research and development expenditures. We think the shares are somewhat undervalued.

Huntington Ingalls Industries is the largest independent military shipbuilder and generates revenue from almost all military shipbuilding contracts. Ships are the longest cycle defense product, as each ship takes years to manufacture and ships are typically purchased in blocks to reduce unit costs. The extended time required to build a ship means that funding for a project is difficult to cut and block purchases give contractors substantial visibility into the progression of revenue. Huntington Ingalls’ top line is, therefore, less sensitive to changes in the defense budget than peer contractors, making it a more defensive play among contractors.

Huntington Ingalls Industries is the largest independent military shipbuilder and generates revenue from almost all military shipbuilding contracts. Ships are the longest cycle defense product, as each ship takes years to manufacture and ships are typically purchased in blocks to reduce unit costs. The extended time required to build a ship means that funding for a project is difficult to cut and block purchases give contractors substantial visibility into the progression of revenue. Huntington Ingalls’ top line is, therefore, less sensitive to changes in the defense budget than peer contractors, making it a more defensive play among contractors.