Huntington Ingalls Industries, Inc. Fundamental Analysis
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Huntington Ingalls Industries, Inc.
Last Updated: 2 Feb 2024
NYSE: HII
GICS Sector: Industrials
Sub-Industry: Aerospace & Defense
Table of Contents
You can download a summary of Huntington Ingalls Industries, Inc' fundamental analysis in PDF here.
Management
CEO: Chris Kastner
Tenure: 1.8 years
Huntington Ingalls Industries, Inc.’s management team has an average tenure of 2.8 years. It is considered experienced.
Business Overview
Huntington Ingalls Industries, Inc. engages in designing, building, overhauling, and repairing military ships in the United States.
For more than a century, the Ingalls Shipbuilding segment ("Ingalls") in Mississippi and Newport News Shipbuilding segment ("Newport News") in Virginia have built more ships in more ship classes than any other U.S. naval shipbuilder, making the company America's largest shipbuilder.
Its Mission Technologies segment delivers high-value engineering and technology solutions to enable multi-domain distributed operations in the government and commercial markets.
Let us look into what each segment does.
Ingalls
In the Ingalls segment, the company designs and constructs non-nuclear ships for the U.S. Navy and U.S. Coast Guard. This includes amphibious assault ships, expeditionary warfare ships, surface combatants, and national security cutters ("NSC").
Fun fact: They are the sole builder of amphibious assault ships and one of two builders of surface combatants for the U.S. Navy. They are also the sole builder of large multi-mission NSCs for the U.S. Coast Guard.
Newport News
The core operations in this segment are the engineering, design, and construction of U.S. Navy nuclear aircraft carriers ("CVN").
Newport News has designed and built more than 31 aircraft carriers for the U.S. Navy since 1933, including all ten Nimitz class (CVN 68) aircraft carriers, as well as the first ship of the next generation Gerald R. Ford class (CVN 78) aircraft carriers.
They are also one of only two companies in the United States capable of designing and building nuclear-powered submarines for the U.S. Navy.
Besides its core operations, Huntington Ingalls is the exclusive prime contractor for nuclear aircraft carrier refueling and complex overhaul (RCOH). RCOH services encompass propulsion work, restoration of service life, and modernization, including various system upgrades.
In 2013, they were awarded a contract to deactivate the decommissioned Enterprise (CVN 65), the world's first nuclear-powered aircraft carrier, which they built and commissioned in 1961. With aircraft carriers typically serving for about 50 years, Huntington Ingalls expects substantial opportunities for inactivation contracts for the active carriers near the end of their lifespans.
Mission Technologies
The Mission Technologies segment has four business groups.
Mission Based Solutions is a business that focuses on solving national security challenges for the Department of Defense (DoD), the intelligence community, and federal civilian agencies around the globe. The group’s expertise includes intelligence, surveillance, reconnaissance, and cyber operations.
Next is the Unmanned Systems, in which products and services create advanced unmanned maritime solutions for defense, marine research, and commercial applications.
The third business group is Fleet Sustainment, which provides comprehensive life-cycle sustainment services. Its services include maintenance, modernization, and repair on all ship classes.
It is this group that provides undersea vehicles and specialized craft development and prototyping services.
The last business group is Nuclear and Environmental Services which focuses on nuclear management and operations. Huntington Ingalls provides site management, decontamination and decommissioning, and radiological and hazardous waste management services.
The company generates revenue from the U.S. Government, including the U.S. Navy, the U.S. Coast Guard, the DoD, the Department of Energy (DoE), and other federal agencies. In 2023, and 2022, approximately 81%, and 82%, respectively, of its revenues were generated from the U.S. Navy.
Huntington Ingalls Industries, Inc. Reportable Segment Revenue FY2023. Source: Gurufocus
Huntington Ingalls Industries, Inc. Revenue Geographic Breakdown FY2023. Source: Gurufocus
Trends, Competition, and Strategy Overview
In the business of designing, building, overhauling, and repairing military ships, Huntington Ingalls competes primarily with General Dynamics and smaller shipyards, which may team up with larger defense contractors.
Although the competition is fierce, the industry has interesting business practices. For example, they may share work among multiple companies. It is also common to compete for a contract award with a peer company and, simultaneously, serve as a supplier to or a customer of such competitor on other contracts.
Being the sole company capable of building, refueling, and inactivating U.S. Navy nuclear-powered aircraft carriers, Huntington Ingalls is well-positioned in shipbuilding markets. However, potential competition from government shipyards entering refueling operations could significantly affect its market position.
The company is also the sole builder of large-deck amphibious assault ships, expeditionary warfare ships, and NSCs for the U.S. Navy and Coast Guard. Furthermore, it is one of two companies capable of designing and constructing nuclear-powered submarines for the U.S. Navy.
But to remain competitive, Huntington Ingalls' must deliver products and services at customer-expected costs, supported by an efficient workforce, technologies, facilities, and financial ability.
Huntington Ingalls' Mission Technologies segment provides technology-based solutions to government and commercial markets. The competitive factors in this space include technological capabilities, cyber advances, integrated solutions, timely delivery, and cost-effectiveness. Success relies on investing in technology while maintaining strong relationships.
This segment competes domestically and internationally against large aerospace and defense companies, primarily L3 Harris, Amentum, ManTech, Leidos, and, increasingly, small businesses serving the intelligence community.
To a lesser extent, its lines of business compete on certain contracts with major contractors, including Lockheed Martin, General Dynamics, Northrop Grumman, Raytheon, and Boeing.
Huntington Ingalls Industries, Inc. Economic Moat
There are many ways to identify Huntington Ingalls Industries, Inc.’s economic moat, but I focus on these 5 sources. The rating is purely subjective and is based on my in-depth understanding of the company.
Huntington Ingalls Industries, Inc. Economic Moat
Economic Moat: Wide
As a prime defense contractor, two key durable competitive advantages exist: intangible assets and switching costs.
Let’s start with Huntington Ingalls’ intangible assets.
The primary source of intangible assets stems from product complexity. These technologies used in arms production demand extensive and specialized expertise. Consequently, new entrants would likely need to either develop this expertise from scratch or acquire it outright.
Furthermore, the development of military programs requires time and expense. Prospective competitors would encounter substantial sunk costs, including recruiting a qualified workforce, as well as investing time and capital into developing prototypes.
The second major intangible asset in the defense industry is the contract structure that allows excess return generation.
There will be fierce competition among prime contractors to secure contracts for prototype development in the beginning. Subsequently, successful contractors progress through stages, starting with low-rate production contracts and transitioning to full-rate production and sustainment. Once the initial purchasing phase concludes, switching contractors is uncommon.
In the early development and production stages, cost-plus contracts are common, shifting cost overrun risks to the customer while limiting potential profit.
As programs advance, they typically transition to fixed-price contracts. Although fixed-price contracts carry more financial risk for contractors, they also tend to be more profitable because manufacturing costs become better understood. Furthermore, mature program contracts, spanning decades, offer added revenue and profit opportunities through the maintenance of delivered weapons systems.
Such intangible assets in the defense industry ensure that incumbent companies are the only companies capable of servicing the military’s large needs, which creates a barrier to entry.
The next source of moat is switching costs.
Switching costs for military customers are driven by product criticality, extended cycles, limited alternatives, and significant investment required for development. Extended procurement cycles, especially for products like submarines provide long-term contracts ensuring sustained revenue and profit visibility over decades.
The effectiveness of a military's strategic objectives depends on product reliability, safeguarding incumbents like Huntington Ingalls from new competition. With product development spanning years, addressing dissatisfaction with existing products through the incumbent contractor is faster and easier than funding the development of new programs.
Based on this framework, let's analyse the moat of Newport News, one of Huntington Ingalls's segments.
The wide-moat segment specializes in nuclear-powered ships. It is the sole-source provider for U.S. nuclear-powered aircraft carriers and operates in a duopoly for submarines.
These shipyards are the only ones in the U.S. capable of such production, and the U.S. government is vested in keeping their strategic and financial viability. The specialized skills and complexity involved in designing, integrating, maintaining, and refueling shipboard nuclear propulsion systems create additional barriers to entry.
Nuclear-powered submarines are also a top priority for the Navy due to their stealth capabilities, and relative affordability.
With orders for new aircraft carriers through the early 2030s and planned submarine procurement extending to the 2040s, Huntington Ingalls maintains a strategic position.
Huntington Ingalls Industries, Inc. Performance
My quick performance checklist:
Has Huntington Ingalls Industries, Inc.'s revenue consistently grown year over year for the past 5 years? Yes.
Is the net income consistently increasing year over year for the past 5 years? Inconsistent.
Has the cash flow from operating activities shown consistent year-over-year growth for the past 5 years? Inconsistent.
Has the free cash flow remained positive for the past 5 years? Yes.
Is the gross margin % consistent or growing over the past 5 years? No, it is declining.
Has the EPS shown growth over the past 5 years? No, it is declining.
In 2023, product sales increased by 5% compared to 2022, driven primarily by higher volumes in aircraft carrier construction, the Columbia class (SSBN 826) submarine program, and the Virginia class (SSN 774) submarine program at Newport News, as well as increased volumes in surface combatants and amphibious assault ships at Ingalls.
Similarly, the cost of product sales in 2023 rose by 5% compared to 2022, reflecting the increased product sales mentioned above.
The service revenues increased by 12% compared to 2022. This growth was primarily driven by higher volumes at Mission Technologies, and increased volumes at Newport News in aircraft carrier engineering and submarine services. However, this trend was partially offset by lower volumes at Newport News in naval nuclear support services.
Similarly, the cost of service revenues in 2023 rose by 11% compared to 2022, aligning with the increased service volumes mentioned above.
Huntington Ingalls Industries, Inc. Revenue, Net Income, Operating Cash Flow, and FCF (USD Million)
Has the free cash flow per share increased over the last 5 years? Inconsistent.
Huntington Ingalls Industries, Inc. FCF per Share
Management Effectiveness
Has Huntington Ingalls Industries, Inc.'s ROE stayed within or above the 12%-15% range year over year for the past 5 years? Yes.
Huntington Ingalls Industries, Inc. Return on Equity
Has the ROIC stayed within or above the 12%-15% range year over year for the past 5 years? No.
Huntington Ingalls Industries, Inc. Return on Invested Capital vs Weighted Average Cost of Capital
The trendline for the number of shares outstanding is declining, which is something that an investor would be pleased to see.
Huntington Ingalls Industries, Inc. Shares Outstanding (Million Shares)
Huntington Ingalls Industries, Inc. executes repurchases under its stock repurchase program from time to time at management's discretion under applicable federal securities laws. The company records all repurchases of HII common stock as treasury stock.
The company initiated its stock repurchase program in Oct 2012. In Jan 2024, it announced an increase in the stock repurchase program to $3.8 billion and an extension of the term to 31 Dec 2028.
Huntington Ingalls Industries, Inc. Financial Health
Huntington Ingalls Industries, Inc. Financial Health (USD Million)
Current Ratio: 0.9 (fail my requirement of >1.0)
Debt-to-EBITDA: 2.1 (pass my requirement of <3.0)
Interest Coverage: 7.8 (pass my requirement of >3.0)
Debt Servicing Ratio: 9.2% (pass my requirement of <30.0%)
Huntington Ingalls Industries, Inc. Stock Performance
The following graph compares the total return on a cumulative basis of $100 invested in Huntington Ingalls Industries, Inc.’s common stock on 1 Jan 2019, to the S&P 500 Index and the S&P Aerospace and Defense Select Index.
The cumulative total return assumes reinvestment of dividends.
Stock Performance. Source: Huntington Ingalls Industries, Inc. 10K
Huntington Ingalls Industries, Inc. Intrinsic Valuation
Estimated intrinsic value: USD $271.92
Value is calculated using the discounted cash flow method (considering their cash and debt) and scenario planning.
Average free cash flow used: USD $580M
Projected growth rate: 8%
Beta: 0.6
Discount rate: 6.0%
Ideal margin of safety: 40% (Uncertainty: Mid)
Price range after the margin of safety: <USD $162.00
Date of calculation: 2 Feb 2024
Huntington Ingalls Industries, Inc. Valuation
I use the past 5 years' free cash flow and apply a weighted average, giving more focus on the recent years. I then round the average to the nearest tens. In some instances, I use a more realistic number to represent the free cash flow.
The total debt and cash and short-term investments are the last quarter figures that are rounded to the nearest tens. In some instances, I use more realistic numbers to represent them.
Huntington Ingalls Industries, Inc. Intrinsic Valuation
Huntington Ingalls Industries, Inc. Relative Valuation
Huntington Ingalls Industries, Inc. Price-Earnings Ratio vs its peers
Huntington Ingalls Industries, Inc. Historical Price-Earnings Ratio
Additional Resources
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My Top Concern
Huntington Ingalls relies heavily on the U.S. Government for its business activities. Most of the company's revenues in 2023 were generated from sales to the U.S. Government, a trend expected to continue. However, conducting business with the U.S. Government involves various risks.
These risks include political and budgetary constraints. Changes in strategic plans are also a concern. Additionally, there is risk related to contract award timing and scheduling changes. Economic downturns can affect government spending, posing further risk. Lastly, there is a risk of contractor suspension or debarment due to legal or regulatory violations.
Any of these factors can harm Huntington Ingalls' financial position.
The next concern is the possibility of significant delays or reductions in appropriations for programs, changes in customer priorities, or contract terminations.
The company is heavily dependent on Congressional funding and a failure to pass appropriations bills may lead to stopgap funding. This may lead to restricted production. Government shutdowns may also further delay or cancel programs.
Fluctuations in defense spending and budget priorities stemming from federal budget uncertainty, political pressures, or legislative actions may influence the demand for Huntington Ingalls' offerings. Moreover, shifts in customer priorities prompted by changes in military strategy or planning may also affect the company’s demand.
As of 31 Dec 2023, Huntington Ingalls' total backlog stood at $48.1 billion, including $26.0 billion in funded backlog. The U.S. Government retains the authority to terminate contracts, either for convenience or due to default based on performance, with minimal prior notice.
Contract termination for convenience allows recovery of incurred costs and profit up to the authorized contract amount but may not cover expected profits from completion. Contract terminations, whether for convenience or default, could result in the cancellation of future work and expose the company to liabilities such as excess re-procurement costs. This can potentially affect its ability to compete for future contracts and impact its business.
Investing in Huntington Ingalls Industries, Inc. presents a complex landscape. Despite its wide economic moat due to its dominant position in the defense sector, recent performance and capital allocation decisions have been less than satisfactory.
The company's balance sheet further adds to the uncertainty surrounding its prospects.
Given these factors, any investment in Huntington Ingalls Industries demands a high margin of safety, with a prudent approach necessitating a margin of safety of at least 40% to mitigate risks effectively. Investors must carefully weigh these considerations before making any decisions regarding involvement with this company.
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