Northrop Records a Loss From Writedowns, Despite Solid Q4 Growth

| About: Northrop Grumman (NOC)

Defense contractors are considered some of the safest stocks to hold in a recession, especially when government spending is expected to remain constant or increase to provide support for the economy during this prolonged recession. With over $600 billion allotted for the defense budget, it’s no wonder the big players in the industry are announcing record backlog orders and double digit profit growth. Northrop Grumman (NYSE:NOC) is the latest contractor to release earnings, and unfortunately, is the latest company to get killed by one-time asset write-downs.

Despite solid Q4 growth, Northrop posted a loss of $2.54 billion after writing off a $3.06 billion charge on goodwill impairment from assets acquired in previous acquisitions made in its shipbuilding and space operations.

The Numbers

Northrop’s CEO Ronald Sugar was completely satisfied with the Company’s results for the year. “[Northrop Grumman's] underlying fourth quarter operating results were outstanding and represent a strong finish to the year.” While fourth quarter earnings per share came in at a loss of $7.76 per share, compared to a profit of $457 million or $1.32 per share a year earlier, excluding the one-time charge, earnings were slightly above analysts’ estimates of $1.55, at $1.57 per share. Fourth quarter revenue increased 4% to $9.15 billion. Full year sales came in up 6% to $33.9 billion, making Northrop the second-largest defense contractor (behind Lockheed Martin (NYSE:LMT)). On top of solid top-line growth, the Company reported record-high total backlog orders of $78 billion, and record-high new business awards of $48 billion for the full year. Fourth quarter free cash flow climbed to $790 million, while full-year free cash flow increased to a record $2.4 billion.

Despite the profit-killing acquisition write-off of Litton Industries and TRW, Northrop’s strong balance sheet has allowed the Company to take measures to increase shareholder value. The defense contractor increased their dividend another 8% in 2008, nearly doubling the dividend since 2003. Additionally, the Company announced that they were able to continue with their stock repurchase plan, and bought back $21.4 million in common shares, leaving another $945 million authorized for repurchasing. Overall, Northrop is sitting in a prime position to create shareholder value in a time when others are struggling just to maintain equity value.

Business Units

Northrop’s Information and Services Unit, which includes such areas as Mission Systems, Technical Services, and Information Technology, experienced a 5% growth in sales the fourth quarter, and increased 6% for the entire year compared to the full year 2007. Although the company posted top-line growth, operating income in Q4 for the segment fell 3%, as Missions Systems was unable to operate nearly as efficient as it did during the same time period a year earlier, which resulted in a decrease in operating profitability of 14%. Sales coming from Information and Technology fell 5%, but a 20% increase in operating income partially offset this drop.

Aerospace sales increased 6% in the fourth quarter and in the full year due to higher volume coming from both the Integrated Defense and Space Technology units. Operating income climbed 18%, but the bottom-line still took a hit due to an impairment charge of $570 million resulting from required annual impairment testing. The Electronics Division recorded a 14% growth in sales, and a 25% increase in operating income resulting from higher sales and improved performance from providing radars and other electronics for restricted programs. The Shipbuilding Division was the only unit posting a decline in sales of 3%, and the enormous impairment charge of $2.5 billion that was described above.

Looking Forward

Despite recording a loss for the entire year, management’s outlook remains strong for 2009. The company provided an earnings guidance between $5.15 and $5.40 per share, compared to the $5.21 per share NOC would have earned in 2008 if not for the unfortunate impairment charge. With a brand new, $14 billion dollar contract to produce 8 Virginia-classed nuclear-powered submarines that will be added to the books in 2009, the company is headed in the right direction. The only problem in the near future will come from a restructuring charge that will be recorded in the first quarter financial report. Let’s hope that’s it for the bad news, because stockholders won’t be too happy to take another loss like they did in 2008.

-Derek Stevens