Why Northrop Grumman May Not Head North

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Northrop Grumman (NYS: NOC) recently recorded 46% growth in its fourth-quarter profits. The company comfortably beat analysts' expectation of $1.68 of earnings per share by posting adjusted earnings of $1.85 per share. But is all well for the defense company?

Behind green numbers
While profits in the quarter increased significantly, revenue continued to be in the red. I plotted the revenue and profits in the chart below to highlight the contradictory pattern between the top line and bottom line over the past six quarters.


Source: S&P Capital IQ

The obvious question: What's sustaining the bottom-line growth despite negative revenues? A couple of things are keeping the bottom line going, including operating efficiencies, lower interest expenses (debt reduction), and share buybacks. While I credit the team for a great performance and effective cash management, how long the situation can last given the lower current volumes and declining defense spending remains a big question.

Not-so-bright future
Northrop expects lower sales and profit in 2012. While the current backlog -- $39.5 billion in 2011 -- was 15% lower than last year, volumes are expected to decline further as the company cuts out non-core and underperforming businesses. The company recently spun off its underperforming $6.7 billion shipbuilding unit, Huntington Ingalls Industries, which affected revenue in the quarter.

As a result of the U.S defense budget constraints, last week the Pentagon canceled its order of Block 30 versions of Northrop's Global Hawk unmanned planes. Although CEO Wes Bush was "disappointed" by this, he said the company was "well aligned" with the defense department's new strategy.

Wait and watch
I am not too optimistic about the alignment, though. Northrop's results are in line with most other defense companies, which are all trimming overhead and making portfolio adjustments. I do not see sustained profitability from cost containment and I hope they are planning for more than that.

The company said that it would now focus on intelligence, cyberspace, reconnaissance, and surveillance. For now, I prefer to wait on the sidelines and see how things pan out before taking the plunge. For more Foolish analysis, click here and add Northrop Grumman to your watchlist. It's free!

At the time this article was published Fool contributor Navjot Kaur does not own shares of any of the companies mentioned in this article. The Motley Fool owns shares of Northrop Grumman. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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