Can Northrop Hold On to Its Big Bomber Win?

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With an estimated $80 billion at stake, the long-awaited Pentagon contract to build the next U.S. bomber was the final jewel in the current round of big, new U.S. Air Force contracts. Northrop Grumman Corp. (NYSE: NOC) took home the prize on Tuesday night with its bid for what is now called the Long Range Strike-Bomber (LRSB), or sometimes the B-3.

The big losers were Boeing Co. (NYSE: BA) and Lockheed Martin Corp. (NYSE: LMT). The two largest U.S. defense contractors had put together a joint bid for the program, and the two issued a statement following the announcement suggesting that they may appeal the Pentagon’s decision:

The Boeing and Lockheed Martin team is disappointed by today’s announcement. We will have further discussions with our customer before determining our next steps. We are interested in knowing how the competition was scored in terms of price and risk, as we believe that the combination of Boeing and Lockheed Martin offers unparalleled experience, capability and resources for this critically important recapitalization program.

As far as price goes, the development cost for the LRSB is currently estimated at $23.5 billion, and the price tag for each copy of the bomber is $564 million. That estimate also was released on Tuesday and is nearly $50 million less than the prior estimate of $606 million. The Air Force is planning to acquire 100 of the planes.

What Northrop Grumman won was the development contract and the right to sell the first 21 planes to the Air Force. The company built the B-2 stealth bomber, and the price for each of those planes rose past $2 billion as technology costs rose past all estimates. The Air Force had originally planned to buy 100 of the B-2s, but stopped at 21 due to the massive costs.

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As for risk, Boeing has been awarded a contract worth an estimated $50 billion for the new Air Force tanker, the KC-46A, and Lockheed is currently building the F-35 fighter for the Air Force, Marines and Navy on a contract that could be worth up to $100 billion over the life of the plane. The Pentagon might have considered that awarding the LRSB to Northrop spreads the risks around better.

In a note to investors cited at Leeham News, Goldman Sachs had this to say about Northrop’s win:

We think this win, along with the existing already very strong investment merits, could drive NOC to be one of the best performing stocks in all of Industrials over the next several years, but do so with substantial visibility and limited volatility. … We think NOC will grow revenue 7-10% at least 2017-2020 and potentially longer, making it essentially a growth company, but with significant visibility. And we think it will generate a ton of cash in the process; potentially moving above $20/share in free cash by the end of the decade.

That is, provided the company can hold on to the contract. Lockheed is currently protesting the award of a $6.7 billion contract to Oshkosh Corp. (NYSE: OSK) to build the Army’s new Joint Light Tactical Vehicle (JLTV, a replacement for the Humvee), and the Boeing-Lockheed team has 10 calendar days following a yet-to-be-scheduled meeting with Pentagon officials to file an official protest of the award. Given that $80 billion is at stake, a protest seems like a cinch.

In after-hours trading Tuesday, Northrop stock rose about 6.4% to $192.15, after closing at $180.58. The stock’s 52-week range is $129.30 to $181.89, and that high was posted Tuesday. The consensus price target is $185.00.

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