Northrop Closure Signals Troubled Times For Defense (NOC)

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Northrop Grumman Corp. (NYSE: NOC) is outlining some of the larger issues in the defense and military spending sector.  The budget for many major defense programs is far less clear than in decades past.  Northrop Grumman announced yesterday that it was closing a large shipyard near New Orleans and that the company plans to consolidate ship building operations in the Gulf Coast region.  More importantly, the company is exploring a possible spin-off of the entire ship building business.  This has all the look and feel of what many other defense firms would see as a changed military and defense spending environment for years to come.

The company, of course, is targeting operating costs, jobs, and that lovely term “efficiency” as it noted an overcapacity in the sector.  The company also admitted that the ship building base will come more in line with new projections for U.S. and allies military spending trends and actual demand.

Northrop’s Avondale shipyard employs roughly 5,000 workers and will close in 2013.  The company noted that its future LPD warships would be built at the Pascagoula, Mississippi facility.  The company is also moving its headquarters from Los Angeles to Falls Church, Virginia.

As you can imagine, politics may play a role in what happens here.  Senator Mary Landrieu of Louisiana is already reportedly set to appeal this decision to the Navy and to the company.  After all, this is jobs in her state.  For a senator or member of the House to appeal closures of facilities or bases is not unusual at all.

Northrup hired Credit Suisse to help it explore strategic alternative alternatives for the unit.  As far as the spin-off, this could come in more than two outcomes.  The company could spin the NewCo off to existing shareholders, it could pursue an outright sale, and it could even decide on making the unit a venture with another military and defense contracting outfit.

These are the new initiatives of Wesley Bush, the relatively new CEO.  Targeting long-term profitability and margins is a goal here.  Big-ticket items such as boats might not be needed for anything more than replacement at this stage in the game.  Many politicians are targeting some of the larger expenses and are trying to target areas that can utilize existing infrastructure.

The company has taken hundreds of million in charges in the last few years over delays, hurricane damage, and other issues brought up by the Navy.  While the nuclear powered ship building facilities are not part of this, it would seem that Northrup could ultimately review that as well.  However, that is a notion we’ll leave for a later date.  The company outlined in this newest ship facility closure that it will have $113 million in consolidation charges, a benefit of $296 million in taxes unrelated to this action, and a net increase to earnings of $0.73 per share.

Whether a buyer or partner will come from the U.S. or from one of the European allies is still not known.  The issue here is that shipbuilding could find itself in the spending cross-hairs for years and years.  Budget cuts and deficit spending as far as the eyes can see are making this fear more of a reality.

With over 120,000 employees, Northrop Grumman is in most major areas of defense spending.  Cutting one major unit out might not be a total game changer.  If it adds to margins, profitability, and leads to a clearer forecasting ability from management regarding future military spending, then it is a cut worth making.

Last year’s revenues were $37.75 billion and Thomson Reuters has estimates at $34,67 billion for 2010 and $35.69 billion for 2011.  There will be charges if the unit is closed or spun out that would exceed just a single facility closure.  That being said, analysts will start tweaking their estimates for 2010, 2011, and beyond.

So far it seems that Wall Street is cheering the notion.  Shares are up 3.1% at $56.97 on over 1 million shares in less than 90 minutes of trading.  The 52-week range is $42.51 to $69.80, and the market cap is just over $17 billion.

JON C. OGG

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