Huntington Ingalls Industries

The largest military ship builder in the U.S.

Date: 13 February 2025

Market Cap: $6.40 B

Price to Earnings: 13.44 times

Price to FCF (FY24): 160 times

Price to FCF (10-year average): 13.3

Price to FCF (FY25 estimate): 13-20 times**

Dividend yield: 3.3%

* FY24 FCF was affected by big change in the “change in working capital” figure on the Cash Flow Statement which was mainly because of a deferral of accounts payable(page 62 of FY24 10-K) This figure should normalize in FY25

**FCF guidance for FY25 is between $300M and $500M

Business Description

HuntingtonIngalls Industries (HII) is America’s largest shipbuilder and a global, all-domain defence provider. With a more than 135-year history of advancing U.S. national defence, the company is united by its mission in service of the nation, creating the advantage for their customers to protect peace and freedom around the world.

HII conducts most of their business with the U.S. Government, primarily the Department of Defence ("DoD"). As prime contractor, principal subcontractor, team member, or partner, they participate in many high-priority U.S. defence programs.

We do not have a clear idea of the exact percentage from revenue coming from the U.S. government, but by looking at the following two tables from their most recent Annual Report we can confidently say that 95% of all sales are attributed to U.S. government contacts.

Segments

Ingalls

The Ingalls division includes the non-nuclear ship design, construction, repair, and maintenance businesses.

Newport News

The Newport News division includes the nuclear ship design, construction, overhaul, refueling, and repair and maintenance businesses.

Mission Technologies

The Mission Technologies division inludes a wide range of services and products, including command, control, computers, communications, cyber, intelligence, surveillance, and reconnaissance ("C5ISR") systems and operations; the application of Artificial Intelligence and machine learning to battlefield decisions; defence and offensive cyberspace strategies and electronic warfare; unmanned autonomous systems; live, virtual, and constructive training solutions; fleet sustainment; and critical nuclear operations.

Segment size by revenue and operating income

Revenue - FY24

Newport News segment is the biggest by revenue bringing in $5.96B in 2024
Mission Technologies brought in $2.93B in 2024
Ingalls brought in $2.76B in 2024

Operating Income

Ingalls is the most profitable of the three segments - 7.6% operating margin
Mission Technologies - 3.9% operating margin
Newport News – 4.1% operating margin

Capital deployment

FY24

Historical share buyback patterns

Since it was spun off from Northrop Grumman on on 31st March 2011 HII management has been reducing their outstanding shares, which is always a good sign as long as their purchases were made at a reasonable price.

At the end of 2011, HII had 48.9 million shares outstanding. At the end of 2024, HII's outstanding shares were 39.5 million. This means that the company has bought back 19% of its shares over the course of 13 years. This is rather signifficant and pleases every value inestor's eye.

Historical dividend growth

HII's dividend has been growing at a steady pace since the company's inception, as seen below.

FY25 Forecast

Management are forecasting FCF between $300m and $500 million which in my opinion is a rather large range. Margins are forecasted to improve slightly as well.

Backlog size

As of December 31st, 2024, the company’s total backlog was approximately $48.7 billion. The company expects approximately 21% of the backlog on December 31st 2024, to be converted into sales in 2025.

Ship procurement process

To help you better understand how the company makes its money, let's look into the ship procurement process and how the US government pays for its naval ships and submarines.

For out example, we will dig into the process of how a $4 Billion Virginia-class sumarine gets purchased

There’s authorization in Congress: the annual National Defence Authorization Act (NDAA) sets defence policy, which grants authority for a program and sets an upper limit on how much can be spent.
A separate appropriation bill grants authority to an agency to spend the money
Finally, when the Department of Defence signs a contract to actually buy a submarine, it obligates the money. However, this doesn’t mean that the contractor gets paid immediately. Instead, the obligated money is a commitment by the U.S. government to pay under the terms of the contract. These terms usually stipulate progress payments. That is, reaching specific milestones like starting hull construction, launching the ship, or completing trials at sea.

The issue lies with the rigidity of these contracts. Not only is labour more expensive today than pre-pandemic, but it is also less productive at HII because of a ‘greener’ workforce of newer hires who are not yet fully up to speed and greater difficulty recruiting and retaining workers as entry-level shipyard pay rivals that of service industry jobs. The obvious way to improve recruitment and retention is by increasing pay. However, because of the rigidly structured progress-based revenue, the company is unable to significantly raise wages.

Risk factors

The most obvious risk is that the company derives 95% of its revenues from government contracts. No investor likes the companies they are invested in to have their revenues coming from practically a single customer. On the bright side, HII is part of a duopoly with sky-high barriers to entry.
Since HII is a manufacturer with relatively low gross margins, a sudden increase in the cost of the raw materials they use would squeeze the company's profits even further.
Labour strikes can significantly impact the company's production output.
The company has classified contracts with the U.S. government, which limits investor insight into a portion of their business.
The company's earnings and profitability depend, in part, upon subcontractor performance and raw material and component availability and pricing.
The company depends on the recruitment and retention of qualified personnel. Lower-level workers can easily use their skills and find jobs in other industries for better money if HII is not offering competitive salaries.
Inability to expand current and future shipbuilding capacity, which sometimes might become difficult if land surrounding the manufacturing plants is already occupied or unusable.
The company could be negatively impacted by security threats, including cyber security threats and related disruptions
Natural disasters such as wildfires, earthquakes, and storms.

Performance metrics

Competition

Main competitors are General Dynamics and BAE Systems which are both bigger companies consisting of more divisions and operating in the US as well as internationally.

Performance metrics

Other companies

Northrop Grumman - HII used to be Northrop Grumman’s maritime division before it was spun off in 2011. Even though NG still operates in the defence sector it is not a direct competitor of HII.
Boing - only specializes in the aerospace sector and does not build naval vessels
Lockheed Martin - Even though LMT is one of the biggest defence players, it does not have a maritime segment, which does not make it a direct competitor of HII.
Fincantieri - Is a ship builder operating in and focusing on the market in Europe. It manufactures cruise ships, yachts, expedition cruise vessels, offshore support vessels for windfarms, as well as oil/gas platform support and maintenance. It does manufacture naval ships and submarines. The company recently won a $1B contract to build the fifth and sixth Constellation-class frigates for the U.S. Navy. We find no reason to dig deeper into the financials for Fincantieri since it is difficult to find any relevant information in their reports.
BWX Technologies - BWX Technologies is not a direct competitor of HII since it only manufactures nuclear components and fuel, whereas HII builds full ships and nuclear submarines. However, BWX is hungry for the same piece of the pie when it comes to the U.S. Defence naval budget, which makes it a good candidate for someone looking to add a defence position to their portfolio.
- Market Cap $10.2B ($4B more than HII’s) but has a revenue of only 2.5B (more than 4x less than HHI’s) and trades at an average 50x FCF over the past 10 years. It also trades at an average P/E of 29.24 over the past 10 years compared to HHI’s 14.8.
- At the price of $109 per share the company only returns $2.31 FCF in 2023, which seems to have been their strongest year (in terms of FCF) in quite a while.

Shipbuilding Sector Findings

As far as the naval segment is concerned, the global defence budget stood at approximately US$ 2.42 trillion in 2023/4, (+10.1% compared to 2022, taking inflation into account), confirming an upward trend since 2014 (+2.6% a year). The current geopolitical scenario is fuelling an increase in defence spending: growth at an average annual rate of +2.6% is expected in the period 2023-27. The spending budget allocated to the naval domain

is also set to grow, supporting demand for all classes of ships.

Valuation

Using the companies 10-year average FCF which adds up to $481M and relatively conservative growth rate targets for normal, best and worst case scenarios we come to a fair value price of $145 per share. Considering that the company is part of a duopoly, the fact that the U.S. government has been underinvesting in its US naval shipbuilding as well as the growing geopolitical tensions it is safe to believe that a smaller margin of safety (20%) is acceptable when valuing Huntington.

Based on all of the above HII will be going into my watchlist with an entry price of $116 per share.

Verdict

Huntington Ingalls Industries is part of a duopoly which certainly makes it an attractive investment. It seems to be far more fairly priced compared to its competition but based on its recent results there is still more to be asked for in terms of margins, growth and cash generation. With its massive backlog of orders, the growing geopolitical tensions and the years of U.S. naval force underinvestment it seems like HII would be a good investment, however, one should always be mindful of the price we pay for our investments and HII’s price is simply too high for our liking at the moment.

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