Military shipbuilder Huntington Ingalls (NYSE: HII) beat its earnings estimates for the fourth quarter of 2018 . In the report delivered earlier this month, it revealed that sales increased 10% year over year for both the quarter and the year as a whole. Profits more than tripled for the quarter, and were up a lower, but still staggering, 82.5% for the year -- to $19.09 per diluted share.
And yet Huntington stock is now actually trading a few pennies below what it cost on earnings day. After an initial rush of enthusiasm over the Q4 results, the market has dialed back its optimism, and so here the shipbuilder's stock sits, becalmed on the ocean's swells.
A contract to build USS Enterprise (CVN 80) will help to swell Huntington Ingalls' backlog of work to be done. Image source: U.S. Navy .
What will it take to get Huntington Ingalls stock moving higher again? Management dropped a few clues in its post- earnings conference call with analysts. Let's listen in .
Get ready to welcome your new aircraft carrier(s)
Let's start with the big news -- a big, new aircraft carrier. Actually the biggest ever built , by anyone, anywhere, the USS John F. Kennedy will be the second carrier of the Gerald R. Ford class . It probably won't be officially delivered to the Navy this year -- but five other warships will: the USS Delaware nuclear fast-attack submarine, two guided missile destroyers, an amphibious warfare vessel and a national security cutter for the Coast Guard.
And after Kennedy is delivered, Huntington will proceed with building two more aircraft carriers for the Navy. Contracts worth $15 billion to build USS Enterprise (CVN 80) and an as-yet-unnamed "CVN 81" were awarded to the company at the end of January.
Backlog is booming
Indeed, based on the backlog of work (and revenues booked, and profits earned), business seems to be booming at Huntington Ingalls these days. The $3.3 billion in new contract awards received in Q4 2018 exceeded the $2.2 billion in revenues it recorded during the quarter by 50% -- a 1.5 book-to-bill ratio -- and that doesn't even count the $15 billion award to build the next two Ford-class supercarriers, which came down after Q4 had already ended.
Huntington Ingalls even landed an order to build six new Arleigh Burke-class guided missile destroyers (DDG 51s). At a unit cost of $1.8 billion per ship , that's nearly $11 billion in revenues -- nearly as much as the price of an aircraft carrier.
Revenues and profits
So revenues are going great guns. What about profits earned on those revenues?
Huntington Ingalls is coming off of a fabulous fiscal 2018 during which operating profit margins hit an all-time high of 12.3%, and margins on "continuing operations" reached 10%. This was great news, but as Petters observed, management doesn't expect these conditions to last forever.
Judging from the comments of its two top executives, 2019 should be the year that things get back to more or less normal at Huntington Ingalls -- "normal" being an operating profit margin of somewhere between 9% and 10% across the company.
Revenues, profits ... and free cash flow
Free cash flow at Huntington was similarly impressive -- not a record high, but still pretty impressive at $451 million in real cash profits, according to data from S&P Global Market Intelligence . Huntington calculates these things differently -- by its estimation, FCF was $512 million. But whichever number you use, the company did set a new record for capital investment, spending $463 million on it last year, which held down that FCF figure.
One piece of good news is that it looks like last year's investments may mean more modest capex spending in the years ahead. In the course of discussing its own Virginia-class program last month, General Dynamics -- which builds those submarines in tandem with Huntington Ingalls -- had a few things to say about capex. In particular, GD management noted that the Block V boat will be "a significant upgrade in size and performance" over Block IV Virginia-class subs, "requiring additional manufacturing capacity" to produce, which accordingly would eat into GD's capital budget.
This doesn't seem to be the case at Huntington Ingalls, however, where the CFO seems confident that simply building a bigger, better Block V boat won't require additional capital investment. Now, a 50% increase in the pace of building those subs might require it to spend more -- but then again, that would bring significant additional revenues to help pay for the capex.
Thinking long term
Yeah, and I would just go and point out that what's actually going to happen here beyond the persistent 3% growth in shipbuilding is that the backlog is going to put us in a place where we're going to be able to talk about not just five years but 10 years. -- Petters
So what does all of this tell us about Huntington Ingalls' long-term prospects as a stock? Here we have the company's two top execs promising a 3% long-term revenue growth rate. And earlier in the call, they reiterated a long-term target of perhaps 9% (or more optimistically, 10%) for the operating profit margin.
Analysts polled by S&P Global are currently predicting a 40% long-term annual earnings growth rate for Huntington Ingalls -- but judging from the executives' comments, this is definitely not in the cards. In fact, given a decline in operating profit margin from 12.3% last year to 9% (or even 10%) in future years, I'd think that even with 3% revenue growth, Huntington Ingalls may find itself challenged just to maintain its current level of GAAP profitability, much less growth it, and much, much less grow it at 40%.
To reiterate: That 40% growth projection is what the analysts are saying -- not what management is promising. As for me, I'd be looking more for a drop-off in profitability at Huntington Ingalls this year, and much slower earnings growth over the next five years, than the 26% (compounded ) rate of income growth that we've seen over the last five.
That won't be welcome news for Huntington Ingalls stockholders, I know, but I think it's better to know this beforehand than to risk disappointment later on.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
