Northrop Grumman Reports Higher Earnings Per Share & Margins On Flat Sales

Defense contractor Northrop Grumman Corporation today reported increased earnings per share in the fourth quarter of 2012 despite softening demand for military goods and services, reflecting the benefits of Chairman Wes Bush’s investor-friendly financial strategy. In the three years since Bush first became CEO of the nation’s fifth-ranked defense contractor, he has divested under-performing businesses, refocused management incentives from revenue growth to shareholder returns, and bought back shares to compensate for flattening military sales. The cumulative effect of these moves has been to improve the company’s financial performance despite a slump in military spending that cut economic growth in last year’s fourth quarter.

Earnings per share rose in the fourth quarter of 2012 by 2% from the prior-year period to $2.14 on sales of $6.48 billion. For the full year, E.P.S. was up 5% from the previous year to $7.81 on sales of $25.2 billion. Average segment operating margins grew by 40 basis points in the fourth quarter from a year earlier to 12.7%, led by robust performance in the company’s Electronic Systems business. Aerospace Systems, the company’s biggest operating unit that includes both aircraft and space businesses, also saw significant margin expansion. Margins declined in the Information Systems and Technical Services segments, presumably reflecting difficult business conditions across the defense sector for short-cycle service businesses.

The company forecast for the year ahead estimates E.P.S. of $6.85-7.15 on sales of $24 billion, with operating margin in the high 10% to low 11% range. The estimates assume continuity in defense spending rather than deep cuts. However, Bush has several tools he can apply if sequestration cuts into sales or operating units experience setbacks. The most potent would be to continue the high rate of share buy-backs that has enabled Northrop Grumman to increase E.P.S. even as sales were slipping. The company repurchased about 21 million of its shares in 2012, allowing total shares outstanding to dip below 250 million for the first time in many years. Bush is also expected to continue reshaping the company’s portfolio of businesses by monetizing franchises that are not a good fit with management’s forward business strategy, an approach that led to spin-off of the company’s under-performing shipbuilding unit early in his tenure as CEO.

In general, Northrop’s financial performance looks much stronger now than it did when Wes Bush first took the helm in 2010. Back then, the company was generating smaller returns for shareholders even though business conditions were markedly better. That was the same year Bush announced that Northrop Grumman would move its headquarters to the Washington area. Whenever Chairman Bush needs a reminder of why financial discipline is so crucial in today’s defense business, he need only look across the street in Falls Church, VA at the headquarters of fellow defense contractor General Dynamics. GD used to be a darling of sector investors while Northrop Grumman was a perennial also-ran. Now the tables have reversed, with Northrop delivering unexpectedly strong results only a week after newly-minted General Dynamics Chairman Phebe Novakovic promised unhappy investors greater realism and discipline in her own company’s results.