Shipbuilding Disruptions And Contract Awards Will Shape The Future

Key Takeaways

• Revenue and margin pressures exist due to reliance on unfavorable pre-COVID contracts and labor and supply chain disruptions impacting program costs.
  
• Achieving future revenue targets relies on resolving current contract issues and executing operational improvements amid financial constraints.
  
• Strong contract awards and operational improvements could drive revenue growth, margin expansion, and improved cash flow, underscoring a positive long-term financial outlook.

Catalysts

Designs, builds, overhauls, and repairs military ships in the United States.

• There is concern that Huntington Ingalls Industries' revenue growth in the shipbuilding segment could be negatively impacted in the short term due to the reliance on pre-COVID contracts, which currently represent about 70% of the shipbuilding revenue and are associated with unfavorable contract conditions.
  
• The company faces potential margin compression due to ongoing labor and supply chain disruptions, which have been exacerbated by inflationary pressures, affecting cost assumptions and leading to unfavorable adjustments on major programs like the Virginia-class submarine.
  
• Huntington Ingalls Industries anticipates challenges in achieving its $15 billion annual revenue target by 2030, as this is contingent on significant operational improvements and successful execution of a considerable backlog, which carries risk if these improvements are delayed or not fully realized.
  
• Free cash flow generation remains a concern in the near term, as the company expects free cash flow to be between $300 million and $500 million into 2025, constrained by elevated capital expenditures and unresolved issues in key contracts, which impact cash collection.
  
• Investors might perceive the potential delay or renegotiation of major shipbuilding contracts to reflect new economic realities as a risk to earnings stability, due to the impact any such changes could have on delivery schedules and cost recovery mechanisms, thus affecting profitability.

Huntington Ingalls Industries Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Huntington Ingalls Industries compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Huntington Ingalls Industries's revenue will grow by 3.6% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 4.8% today to 5.2% in 3 years time.
• The bearish analysts expect earnings to reach $672.0 million (and earnings per share of $17.65) by about April 2028, up from $550.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 11.8x on those 2028 earnings, down from 15.5x today. This future PE is lower than the current PE for the US Aerospace & Defense industry at 30.0x.
• Analysts expect the number of shares outstanding to decline by 0.77% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.82%, as per the Simply Wall St company report.

Huntington Ingalls Industries Future Earnings Per Share Growth

Risks

• Huntington Ingalls Industries expects to secure over $50 billion in contract awards over the next 24 months, which could significantly boost revenue and provide opportunities for margin expansion to historical norms.
  
• By focusing on operational improvements such as increasing throughput by 20% and achieving cost reductions of $250 million annually, the company anticipates improved operational execution that could positively impact net margins over the medium term.
  
• The company forecasts growing to $15 billion in annual revenue by 2030 with associated margin expansion opportunities and increased free cash flow, suggesting a long-term positive outlook on financial performance.
  
• Mission Technologies achieved substantial awards, including its largest-ever $6.7 billion contract, and experienced 9% revenue growth year-over-year, indicating strong potential for revenue and earnings strengthening.
  
• HII has seen significant demand for its products and services, with a $49 billion year-end backlog, implying stable future revenue streams and potential for long-term earnings growth.

Valuation

• The assumed bearish price target for Huntington Ingalls Industries is $171.45, which represents one standard deviation below the consensus price target of $218.84. This valuation is based on what can be assumed as the expectations of Huntington Ingalls Industries's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $312.0, and the most bearish reporting a price target of just $165.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $12.8 billion, earnings will come to $672.0 million, and it would be trading on a PE ratio of 11.8x, assuming you use a discount rate of 6.8%.
  
• Given the current share price of $217.93, the bearish analyst price target of $171.45 is 27.1% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.