General Dynamics Corporation (GD), Northrop Grumman Corporation (NOC): Should Investors Be Happy About An Additional $4 Billion Share Buyback?

Northrop Grumman Corporation (NYSE:NOC), a leading global security company, is buying back an additional $4 billion of the company’s common stock, totaling the authorized share repurchase amount to about $5 billion, which is near 27% of the current market cap of $18.58 billion as of May 16, 2013. Northrop Grumman Corporation (NYSE:NOC) plans to retire about 25% of its shares outstanding by the end of 2015. The company will use its cash balance or free cash flow to fund the repurchase and issue debt if necessary. Earlier, Northrop Grumman Corporation (NYSE:NOC) had also increased its dividend by 11% to $0.61 per share. Northrop is working aggressively to create value for its shareholders.

By digging further and take a look at Northrop’s balance sheet and free cash flow, investors may want to pause before jumping in. First, as of March 31, 2013, Northrop Grumman Corporation (NYSE:NOC) had $3.18 billion total cash and $3.94 billion in total debt. Second, despite the earnings beat in the last quarter, the free cash flow was not pretty for Q1, as seen from the chart below. Lastly, by increasing its dividend, the company will likely need to borrow to fund the accelerated share repurchase. Northrop Grumman Corporation (NYSE:NOC)’s current debt/equity ratio of 0.4 is better than Lockheed Martin Corporation (NYSE:LMT)’s debt/equity ratio of 20.2 and the industry average of 0.7, but slightly higher than its close rival, General Dynamics Corporation (NYSE:GD)’ debt/equity ratio of 0.3.

Source: YCharts.com

Lockheed Martin Corporation (NYSE:LMT) is the No. 1 defense contractor in the US, whereas General Dynamics Corporation (NYSE:GD) offers a broad portfolio range from tanks, to IT, to weapons. While both companies and Northrop won’t be significantly  impacted significantly for their profit due to sequestration, their sales already be negatively impacted by the budget cuts. Cost cutting is essential for these three companies to maintain profits, while the revenues are expected to be pressured further in the second half of the year, and even more so in 2014.

General Dynamics Corporation (NYSE:GD) is also facing the same situation as Northrop Grumman Corporation (NYSE:NOC). General Dynamics had increased its dividend by 10% to $0.56 per share in March and informed investors to expect more “shareholder-friendly” share buybacks in 2013. Taking a look at the chart below, General Dynamics Corporation (NYSE:GD)’ free cash flow does not look promising either with increasing dividend. That might be one of the reasons why Berkshire Hathaway Inc. (NYSE:BRK.A) sold its stakes in General Dynamics Corporation (NYSE:GD).

Source: YCharts.com