Increased demand for its products could catalyze Northrop Grumman's (NOC, Financial) stock price. The U.S. Air Force is expected to increase in size in order to counter growing threats, while other countries such as Japan are seeking to improve their defense capabilities.
The aerospance and defense company’s acquisition of Orbital ATK could provide it with synergies. It may also allow it to access the fast-growing "new space" industry.
The company’s stock price has increased 1% in the last year versus a 9% rise for the S&P 500. Although its CEO is set to depart at the end of the year, outperformance of the index could be ahead.
Aerospace growth
A significant expansion of the U.S. Air Force could catalyze Northrop Grumman’s financial performance. The U.S. is seeking to counter rising threats from technologically advanced countries around the globe, while also fighting more localized insurgencies. Both areas require a major contribution from the Air Force, and the service plans to increase its current 312 squadrons by 24% to 386 by 2030.
Included in this figure is five bomber squadrons, taking their total to 14. This suggests demand for Northrop Grumman’s B-21 bombers could increase. An additional 22 command and control and intelligence squadrons are also said to be required by the U.S. Air Force. This could lead to higher demand for the unmanned systems produced by the company.
Other countries are also seeking to increase their defense capabilities. Japan is expected to grow its fleet of Hawkeye aircraft. The country intends to purchase up to nine Early Warning and Control (AEW&C) aircraft, along with spare engines, GPS and other equipment to keep them in the air. At a cost of around $350 million per plane, the order amounts to 26% of Northrop Grumman's annual aerospace revenue.
The company is also considering entering the race to supply Japan’s next-generation fighter jet. The defense company is rumored to have been encouraged by Japan’s Air Self-Defense Force to compete for the deal in what is expected to be a major overhaul of its existing ageing jets. Competing could provide the company with a new line of business, with the cost of exploring a bid being relatively small.
Space potential
The acquisition of Orbital ATK provides Northrop Grumman with a better-targeted range of opportunities within the fast-growing space industry. It increases its exposure to small satellites, small rockets and the wider industry that is becoming known as "new space."
Smaller missions and smaller spacecraft are set to become increasingly prevalent. The space launch services market is forecasted to grow at a compound annual rate of 16% between now and 2026 to reach $37 billion. Orbital ATK could provide the company with wider access to the growing market. While Northrop Grumman had previously been focused on larger-scale items, it now has the capacity to become a more dominant entity across a range of markets. With the acquisition of Orbital ATK set to deliver $150 million in cost synergies by 2020, it is also improving the company’s efficiency.
Management change
CEO Wes Bush's decision to step down at the end of the 2018 calendar year came as a surprise to many shareholders. The company is still in the process of integrating Orbital ATK and has faced a period of relatively challenging news flow. For instance, cost overruns and errors have contributed to a delay in the launch of the James Webb space telescope.
Bush's successor is Kathy Warden, who has been at the company for over 10 years. She has industry experience at GE (GE, Financial) and General Dynamics (GD, Financial), and seems to be the obvious choice given her position as chief operating officer. As the handover period is expected to extend through July 2019, the management transition could be relatively smooth.
Outlook
Rising demand for defense products from the U.S. Air Force and other countries such as Japan could stimulate Northrop Grumman’s financial performance. Its acquisition of Orbital ATK provides it with an additional growth catalyst within the rapidly-growing new space industry, while also providing synergies over the next several years.
Although a change in management is a risk facing the company at a time of significant growth, buoyant end markets could reduce this risk. An internal promotion may also lead to a continuation in strategy, rather than a major change. Having underperformed the S&P 500 in the last year, the stock appears to have investment appeal.
Read more here:
