Why RiverPark Sees Growth Potential in Northrop Grumman (NOC)

In its Q2’18 investor letter, the RiverPark Large Growth Fund discussed Northrop Grumman Corporation (NYSE: NOC) and other stocks. In this article, we’re focusing on Northrop Grumman whose shares, according to the fund’s letter, “detracted from performance for the quarter as the defense sector, as a whole, reacted negatively to the lessening of tensions with North Korea as well as sector rotation away from this previously outperforming category.” However, the fund believes that the company is “well positioned to outgrow the industry given its focus on aerospace, high technology content and the potential synergies from the Orbital ATK acquisition.” Let’s take a look at the fund’s comments about NOC.

NOC shares detracted from performance for the quarter as the defense sector, as a whole, reacted negatively to the lessening of tensions with North Korea as well as sector rotation away from this previously outperforming category. NOC’s decline in the quarter was despite the positive news of the company closing its Orbital ATK acquisition and management increasing guidance for both EPS and FCF.

We believe that the defense industry’s fundamentals have improved substantially over the past year given the anticipated increase in defense spending following several years of sequestered budgets. We also continue to believe that Northrop is well positioned to outgrow the industry given its focus on aerospace, high technology content and the potential synergies from the Orbital ATK acquisition. NOC has about 20% of its revenue coming from aircraft programs, such as the B-21, E-2D, and the F-35 (up 30% year-over-year in the first quarter), which are growing at more than 20% per year – a significantly higher rate than overall defense budget growth (anticipated to be 5-6% per year). NOC also has the potential to win a large portion of the pending $100 billion Ground-Based Strategic Deterrent intercontinental ballistic missile weapon system program that is expected to be awarded in 2019. Although the Street expects mid-to-high single-digit revenue growth for the company, relatively in-line with the expected defense budget growth, we believe the company can comfortably exceed that growth rate while also further expanding its margins through increased scale and strong execution. We continue to look for double-digit operating income growth from NOC in the years to come that should continue to be augmented by strategic acquisitions, debt pay down and continued share buybacks from more than $2 billion of annual free cash flow.

Shares of Northrop Grumman Corporation (NYSE: NOC) are up 3.58% since the start of the year. The stock, over the past three months, has moved up 1.33% while the share price has jumped 13.27% over the past 12 months. NOC – which was closed at 312.26 on Wednesday – has a consensus average target price of $360 and a consensus average recommendation of ‘OVERWEIGHT’, to analysts polled by FactSet Research.

If we look at our database, Northrop Grumman isn’t a very popular stock among hedge funds covered by Insider Monkey. As of the end of the second quarter of 2018, there were 41 funds in our database with positions in the company.

Disclosure: none