Moving Higher

Howard A. Rubel
Jefferies
212-284-2126
[email protected]
Northrop Grumman (NOC) reported Q3 2011 EPS of $1.86 vs. our estimate of $1.62. The differential was due to better operating profits in Aerospace and Electronics ($0.14), lower general corporate expenses ($0.06), a lower tax rate ($0.05), and a reduced sharecount ($0.02), offset by $0.03 of higher intersegment eliminations. NOC continues to take aggressive measures to rationalize its portfolio for a challenging budget environment and reduced op[erational] tempo.

We are raising our 2011 EPS by $0.15 to $7.10 and lowering our 2012 EPS by $0.05 to $7.45. Portfolio trimming pressures revenues, but also creates a leaner and more focused business. NOC should continue to generate annual free cash flow above $1 billion before pension contributions. We decreased 2012 revenues by about $1 billion to $26.7 billion, but a lower sharecount offset most of the revenue reduction. A flat to slightly down defense business, which can continue to generate strong cash flow to reduce sharecount, is the sector's new growth company.

Management continues to focus the company in four areas: Cyber, C4ISR, Unmanned and Logistics. Management has identified these areas where the company can offer a differentiated product or service.

Each of these areas of the budget is expected to be mostly insulated from deep cuts. None of NOC's major programs is believed to be a significant cause for concern. Information Systems is likely the most vulnerable. We have revenues in the segment trending down to about $7.7 billion in 2012 from $8.1 billion in 2011. Information Systems (IS) is one area receiving particular emphasis for portfolio shaping. The sale of the County of San Diego outsourcing contract, about a $400-million annual business, is one example. It is also impacted by the Continuing Resolution and reduced funded from budget disruptions.

Joseph B. Nadol III
J.P. Morgan
212-622-6548
[email protected]
NOC delivered another strong quarter driven by better than expected margins, and management raised guidance for the year … Management's 2012 pension guidance was much better than we anticipated, and we are increasing our 2012 and 2013 GAAP EPS estimates accordingly (although it is important to note that changes in pension estimates have no impact on our price target or rating as we derive both from pension-adjusted numbers).

We are increasing our 2011 EPS estimate by 20 cents from $6.85 to $7.05 due to 30 basis points of margin improvement and a lower than expected sharecount. We are also increasing our 2012 and 2013 EPS estimates by $1.00 and $1.05 to $6.60 and $6.40, respectively, due largely to our much improved pension outlook. A lower sharecount also helps, while our underlying operating outlook remains essentially intact. n