krause fund research fall 2020 industrials northrop

Important disclosures appear on the last page of this report.

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Krause Fund Research Fall 2020 Industrials Recommendation: BUY

Analysts: Jacob Lenz

[email protected]

Billi Marzen [email protected]

Company Overview Northrop Grumman Corp. (NOC) is a leading global security company. Dealing primarily with the government, they deliver innovative platforms, systems, and solutions for applications ranging from undersea to outer space and into cyberspace. It operates through 4 segments: Aeronautics Systems, Defense Systems, Mission Systems, and Space Systems. Northrop Grumman was founded in 1939 and is headquartered in Falls Church, VA. Stock Performance Highlights 52 week High $385.01 52 week Low $263.31 Beta Value 0.77 Average Daily Volume 1.22 m Share Highlights Market Capitalization $48.317 b Shares Outstanding 166.71 M Book Value per share $68.09 EPS GAAP | Adj. 2019 $13.22 | 21.21 P/E Ratio 19.88 Dividend Yield 1.5% Dividend Payout Ratio 38.86% Company Performance Highlights ROA 5.7% ROE 26.4% Sales $33.84 b Financial Ratios Current Ratio 1.13 Debt to Equity 1.57

Northrop Grumman Corp. (NYSE: NOC) November 17, 2020

Current Price $312.74 Target Price $360-375

Investment Thesis

We recommend a BUY rating for Northrop Grumman due to continued stable defense spending, growth in the space sector, and their increase in backlog. Our target price is $360-375 which represents roughly a 17% increase from their current price.

Drivers of Thesis • With Biden as president, defense spending is not predicted to shift from the current federal funding plan, which is expected to increase 7% in 2020, 2.7% in 2021. • Space business will be an important driver in future growth as new technologies create product differentiation, boosting Space Vehicle & Missile Manufacturing growth by 2.5% in 2020. • Northrop Grumman backlog is up by 81 billion, or 25% in 2020. This is due to a growing amount of government contracts, the GBSD (Ground Based Strategic Deterrent) contract for $85 billion being their largest one.

Risks to Thesis • Due to the COVID-19 pandemic and Biden taking the presidency, another round of stimulus is likely to occur. This will increase the current budget deficit and could have an adverse effect on overall spending. • Northrop’s primary client is the U.S. government. Since defense spending is always a topic of debate, the government could mildly cut down on defense spending. As a result, Northrop would experience a decline in revenue.

One Year Stock Performance


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Economic Outlook

Defense Spending Being that Northrop Grumman is highly reliant on the U.S. Government for business, U.S. defense spending is of high importance. Defense spending is a major portion of the overall U.S. budget. It is the second largest budgetary item below Social Security1. In 2020, President Trump grew defense spending by 7% to $738 billion. In 2021, the proposed National Security budget is $740.5 Billion, of that amount, $705.4 Billion is for the DoD3,6. Since 2016, total defense spending has increased by an average of $42 Billion YoY, or an average increase of 5.1% YoY. However, in more recent years the annual growth of the base budget has slowed and begun to level out1.

*Data Sourced from worldbank.org With growing concerns over paying off the $3 Trillion spent by congress to fight COVID shutdowns, the SECDEF believes that there will not be major increases in DoD spending in the near future16. With Joe Biden winning the 2020 presidential race, there are still no radical shifts predicted in defense spending. He intends to shift defense spending investments towards technologies and innovations like cyber, space, and AI10. It’s predicted that the 2022 proposal in defense spending would be cut by around 5% or $35 Billion to be phased in over 5 years16. Overall, it seems that defense spending will continue to remain at a relatively stable level over the near future.

Industrial Production Index The industrial Production Index is an economic indicator in the industrial sector. It measures real output for all manufacturing facilities in the U.S. It is a good indicator of monthly growth in the industry8. This Index can be further categorized into the production of Defense and Space Equipment which is where Northrop Grumman primarily operates. Prior to the pandemic, the index had grown a total of 14% since 2016. From February to April 2020, there was a steep decline in production totaling 14.11%8. This decline was likely due to manufacturing facilities being shut down from the COVID outbreak. However, since April, there has been a recovery seen with an average monthly growth of 2.46%. As of September, the index was at 101.4. This is close to pre-pandemic levels which were around 1048. This is a good indicator that industrial production will continue its recovery and return to stable or growing levels. However, with recent spikes seen in COVID cases, production could be negatively impacted by this if manufacturing shutdowns are mandated again.

*Data Sourced from stlouisfed.org

Capital Markets Outlook With current spikes in global COVID cases, the market growth and recovery that was recently seen has been slowed. Additionally, the recent presidential election has only added more tension, and created more volatility in the markets. We believe this volatility will continue to be seen, keeping growth relatively minimal

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through the remainder of 2020. Once a vaccine has been released to the public, the pandemic resides, and tensions from the presential election reside, we are predicting that the markets will see continued growth similar to pre-pandemic conditions. Interest Rates Being that the Defense Industry is so capital intensive, Interest Rates have a major impact on companies like Northrop Grumman. With inflation rates currently at low levels, The Federal Reserve expects interest rates to remain near zero for years to come15. With interest rates remaining low, it will provide Northrop Grumman the ability to increase their expenditures. This will allow them to continue their growth in different segments, without having a major increase in their cost of capital. The ability to raise new capital without having to increase their costs provides a major opportunity for growth.

Industry Analysis

Demand Analysis In the defense industry, the primary customer is the government which demands weaponry and vehicles for the military. The U.S. government is expected to direct a substantial amount of its budget towards homeland security. Therefore, this industry is guaranteed business no matter the economic stage. However, in more recent years, federal funding for defense has begun to mildly increase due to changing technologies and geopolitical tensions in Asia, Europe, and the Middle East. This has further increased the need for the U.S. to spend more on the military to prepare for potential conflict with rivals such as China and Russia. Supply Analysis The suppliers of defense products are firms that develop and produce technical and scientific

products. These firms’ primary customers are the defense and space agencies of the Federal Government who demand aircraft, missiles, spacecraft and research. This Government-Industry relationship is dominated by the constantly changing needs of the government. The defense contracts are awarded by the government to a main group of suppliers based on reputation and technical competence which makes this industry competitive and difficult to enter. Porter’s Five Forces Competition: In the government-Industry relationship the price system does not assure a high degree of competition because of the economic, legal, and technical barriers. Therefore, competition is typically eliminated, and existing firms focus on maintaining relative market position by creating modern products that suit the government’s needs.5 Bargaining Power of Customers: The smaller the customer base for Northrop Grumman, the more bargaining power for discounts their customers have. Northrop’s main customer is the U.S. Department of Defense which has high bargaining power since the pentagon controls how much defense firms can make by purchasing defense contracts. Bargaining Power of Suppliers: As a diversified firm, Northrop purchases their raw materials from numerous suppliers. Northrop has built an efficient supply chain with multiple suppliers to keep supplier bargaining power low. They experiment with different materials from different suppliers so that if prices of one raw material go up, then they can easily switch suppliers or negotiate a better price with the supplier.5 Threat of Substitutes: In the industry that Northrop Grumman operates, there are very few substitutes for the weaponry and aircraft they produce since these products are typically customized for a specific governmental need.


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Therefore, it is not likely for a substitute to be readily available and so there is no profit ceiling for the few firms that operate in this low profit sector. Threat of New Entrants: The capital requirements for the industry that Northrop operates in are high, making it difficult for new entrants to cover expenditures for R&D costs. Government policies also require strict licensing and legal requirements to be fulfilled before a firm can begin to sell these products. Therefore, the threat of new entrants is a weaker force in the A&D industry. Peer Comparisons

The book to bill ratio is the ratio of orders received to the amount billed over a specific period. This chart shows each firms BB ratio for the past quarter (3rd). Northrop Grumman had the strongest BB ratio of 2.2, meaning that the firm has more orders received than filled, indicating strong demand. The firm was awarded a net of more than $20 billion, their biggest contract being with the Ground Strategic Deterrent program for $13.3 billion. However, their backlog increased to a historical record of $81.3 billion. S.W.O.T. Analysis Strengths Northrop Grumman is most successful at entering new markets and executing new projects to build revenue and generate adequate returns on capital expenditure. Because of this, it has reached most of its potential market and is

not majorly impacted by economic downturn, operating on primarily government contracts. Weaknesses Northrop Grumman is continuously expanding, and in order to do this it has to spend more than its competitors on modern technologies. Northrop also has a large defined benefit obligation while many of its competitors have undergone pension freezes. Opportunities The average contract Northrop Grumman holds with the government is 5 years, which calls for the adoption of new technology. Acquiring new technology gives Northrop a competitive advantage and enables it to enter new markets, improve their products, and increase market share. Threats Defense spending is Northrop’s largest threat since congress has the ability to cap how much firms can make in this industry. If congress decides to flatten the budget, Northrop could have fewer opportunities in the market place. With Biden in office and a substantial budget deficit, defense spending could decrease in the years to come.

Company Analysis

Company Overview Northrop Grumman, Corp. (NOC) is a leading global security company. It carries out defense contracts for the U.S. Government and delivers applications from under the sea to outer space, and into cyberspace. Up through 2019, it operated through 4 segments: Aerospace Systems, Innovation Systems, Mission Systems, and Technology. Since their acquisition of Orbital ATK, they have been restructuring the segments of their company. As of Jan 1 2020, their new operating segments are: Aeronautics, Defense Systems, Mission Systems, and Space Systems. The U.S.

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NorthropGrummans

GeneralDynamics

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Government is Northrop’s largest customer accounting for roughly 85% of annual sales. Their sales contracts are a combination of cost and fixed type contracts. Northrop has more than 550 facilities in the U.S. and is headquartered in Falls Church, Virginia. 14

Aerospace Systems Aerospace Systems is a leader in the design, development, integration, and production of manned aircraft, autonomous systems, spacecraft, high-energy laser systems, microelectronics and other systems13. Their systems are used in mission areas including intelligence, surveillance and reconnaissance (ISR), strike operations, communications, and space science. This sector is reported in three business areas reflecting their core capabilities: Autonomous Systems, Manned Aircraft, and Space. Some main product lines in this segment are the F-35 Lightning II, the Global Hawk System, C4ISR programs, and the B-21 Bomber13. Aerospace Systems generated $13.86 Billion in sales in 2019 which was a 5.85% increase from 2018. This increase in sales was primarily driven by an increase in their E-2D and F-35 production. We are predicting a continued total growth of roughly 3.7% over the next two years being driven by a continued higher production of the F-35 and the E-2 programs13.

Innovation Systems Innovation Systems is a frontrunner in the design, development, integration and production of flight, armament and space systems13. Major products include launch vehicles and propulsion systems, missile products and defense electronics, precision weapons, armament systems and ammunition, satellites and associated space components, and advanced aerospace structures. This sector is reported into three business areas reflecting their core capabilities: Defense Systems, Flight Systems, and Space Systems. Some key product lines in this segment include the anti-radiation guided missile (AARGM), rocket motors for NASA’s Space Launch System (SLS), and the Cygnus spacecraft. This is Northrop’s newest business segment stemming from their acquisition of Orbital ATK. In 2019 it saw a total revenue increase of 86.78% which we expect to stabilize in future years now that the segment has become fully integrated into the company. Continued flight systems sales and space system sales will ensure this segment remains at stable levels13. Mission Systems Mission Systems is a leader in advanced end-to-end solutions and multifunction systems. Their major products and services include C4ISR systems, radar, sensors, electronic warfare systems, cyber solutions, space systems, Air and Missile Defense (AMD) integration, navigation, and missile launch systems. This segment is broken into three sectors: Advanced Capabilities, Cyber and ISR, and Sensors and Processing. Some key specific products include the integrated Air and Missile Defense Battle Command System (IBCS), the Surface Electronic Warfare Improvement Program (SEWIP), and the Scalable Agile Beam Radar (SABR). In 2019, total revenue was up by 4.73% which was carried by higher sales in all three sectors. We expect this segment to continue total revenue growth by around 2.4%

38.13%

16.83%11.31%

33.73%

2019 Revenue Decomposition

Aerospace Systems Innovation Systems

Technology Services Mission Systems


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being driven by increased production as service revenue is predicted to slowly decrease13. Technology Services Technology Services are a leader in delivering full life-cycle solutions and services in support of mission-critical networks and systems. This segment is focused primarily on providing services and is Northrop’s smallest segment. It is divided into two segments which are Global Logistics and Modernization, and Global Services13. Key services it provides are repairs and modernization for electronic/avionic products such as the Global Hawk and Triton Systems, specialized sensors, and the Intercontinental Ballistic Missile Minuteman III. In 2019, total sales saw a decrease of $187 Million or -4.35%. This decline was primarily due to 2018 completions of a state and local services contract and the JRDC Program. We are predicting total sales to continue decreasing at a slow rate due to their increased focus on products rather than services13. Company Restructuring As previously mentioned, as of Jan 1st 2020, NOC restructured their business segments into the following categorizations: Aeronautics, Defense Systems, Mission Systems, and Space Systems14. Aeronautics is an innovative and autonomous air systems provider, with a proven track-record of systems engineering, manufacturing excellence and reliability. Defense Systems brings together technology services, Orbital ATK’s defense businesses and select Mission Systems Capabilities. Mission Systems is a C4ISR tech leader in open, cyber-secure, software-defined systems for defense and intelligence applications across multiple domains. Then Space Systems is a leader in delivering end-to-end mission solutions through the design, development, integration, production, and operation of space, launch, and missile systems.14

Restructured Revenue As of 9 months ended September 30th, NOC’s restructured segment sales performance is as follows. Aeronautics had $8.68 Billion in total revenue YTD. This was a 4.49% increase from adjusted 2019 sales to allow for proper comparison. This is currently Northrop’s largest segment accounting for 31.2% of total sales YTD. The 4.49% increase was due to higher sales in both manned and autonomous systems. Defense Systems had $5.62 Billion in total revenue YTD. This was a .2% increase from adjusted 2019 sales. Defense Systems sales has accounted for roughly 20% of total sales YTD. Mission Systems had revenue of $7.34 Billion YTD. This segment has seen an overall increase in revenue of 6.07% and has accounted for roughly 26.4% of total revenue YTD. The 6.07% increase is from a higher volume in all 4 segments. Space Systems has had a total revenue of $6.19 Billion YTD which is an increase of 13.15% from 2019. Space Systems revenue has accounted for roughly 22.2% of total sales YTD. Their increase in revenue was seen due to higher sales in both space and launch & strategic missiles, and increased sales from NASA related Programs12.

*Source: Northrop Grumman Q3 10-Q Report

31.20%

20.20%26.40%

22.20%

2020 YTD Revenue Decomposition

Aeronautics Defense Systems

Mission Systems Space Systems


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Backlog At of 9 months ended September 30th, NOC has seen an increase in total backlog of $16.4 Billion to $81 Billion. This is a 25% increase in 2020. This dramatic increase is led by a 121% increase in Space Systems backlog since being implemented at the beginning of the year12. This is very promising for Northrop, as backlog is a indicator of future sales to occur from contracts in place with the company. Risk Factors One main risk factor faced by the company is seen with the COVID-19 pandemic. While the pandemic hasn’t had a major impact internally, the pandemic could have an adverse impact on the company in other ways. This would include potential disruption in the supply chain if continued global spread causes disruption in the supplier’s workforces. This could create difficulty in attaining access to necessary components and supplies11. Additionally, it is important to note continued government spending on COVID-19 relief. If the deficit continues to grow at its current rate, there will likely be future budget cuts to certain areas including defense spending. This will likely not have any noticeable major short term impacts due to the longevity of government contracts. However, if big enough cuts are made this could lead to lower creation of new contracts with the government, affecting longer term growth. Since the government is Northrop’s largest customer accounting for 85% of their sales, this will be something to watch.

Valuation Assumptions

We arrived at a final target price, ranged from $360-$375. We arrived at this range by using the Mckinsey method of DCF and EP, and sensitivity testing their variables to ensure accuracy. This value was driven by forecasted revenue growth, margins, earnings estimates and terminal growth.

Revenue Growth We started our valuation model by first creating a revenue decomposition for Northrop’s 4 segments: Aerospace Systems, Innovation Systems, Mission Systems, and Technology Services. First, we found each segment’s historical product and service sales in relativity to total sales to help forecast years 2020-2025. We were then able to calculate the growth rate each year based on our assumptions made. Overall, we expect Northrop’s sales to grow by a higher amount in the nearer years (2020-2021), and to become more stable in the years following as they approach a stable growth rate. Aerospace Growth We assume the highest growth in this segment through the CV year 2025 due to their current higher production of the F-35, and E-2 programs. Though product sales are growing at a high rate of 4%, services are barely growing by 1%, causing the overall growth rate in this segment to be slightly lower. Mission Systems We assume second highest growth in this segment as product sales have been increasing by 5% over the past 2 years and are projected to increase by 5% in 2020 and 2021 due to their focus on designing new technologies. However, service growth is down due to this focus, and will approach near 0% growth through 2025. Innovation Systems Growth Innovation systems was a segment of Northrop Grumman from 2018-2020 due to the acquisition of Orbital ATK Inc. As their last year with this sector, we assume high growth of 3.5% in 2020 and near 0% in the later years. This was determined with the notion that sales growth will level out, and they will shift their focus to other segments and restructuring.


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Technology Services Growth We expect technology services to grow in revenue by under .5% each year. This segment is Northrop’s smallest segment and primarily focuses on services. With completions of multiple contracts in 2018, we are expecting service sales to continue decreasing, but for product sales to slowly increase due to a shift in focus towards product in this segment. Expenses We forecasted product costs and service cost as a percentage of their respective sales. Our percentage used to forecast these was based on the average of the previous 5-years. We believe that this was appropriate given the low historical volatility these costs faced as a percentage of sales. We followed a similar method when forecasting SG&A costs as well. We forecasted this expense as a percentage of total net sales. We felt this is an accurate representation as well given the low volatility in historical SG&A costs as a percentage of sales. Cost of Equity We used the CAPM model to calculate the cost of equity. The Risk-free Rate we used in our calculation was from a 10-year Treasury Bond. The equity risk premium used was taken from Damodoran’s website from 1961-October 1, 2020. Our beta was calculated based off information pulled from Bloomberg. This was based off of the 5-year weekly avg of the beta. Using these three values allowed us to arrive at a Cost of Equity of 4.96%. Cost of Debt In calculating the Cost of Debt, we used a marginal tax rate based off current federal taxes. The pre-tax cost of debt was taken from the Bloomberg yield given on a 30-year NOC Corporate Bond. Using these values allowed us to calculate an After-Tax Cost of Debt of 2.28%.

WACC The Market Value of Equity was calculated out to be 52,945.19. This was done by using the current stock price and multiplying it by total shares outstanding. The overall weight of Equity was 76.68%. The Market Value of Debt was calculated out to be 16,103.09. This was done by taking the sum of Short-Term Debt, the Current Portion of Long-Term Debt, Long Term Debt, and the PV of operating leases. The overall weight of Debt was 23.32%. We were then able to use these values to calculate the value of WACC, which was 4.34% CV Growth Rate Our research on the Aerospace and Defense Industry and on Northrop Grumman led us to using 1% as our Continuing Value. This rate was determined due to the quickly growing deficit and to uncertainty on future government spending. Even with no indicator of spending slowing in the near future, their growth could be hindered by a growing deficit with more stimulus packages leading to reduced future spending. Thus we used a conservative value to ensure we wouldn’t overestimate future growth. This value is considered to be a safe rate given it is lower than the current inflation rate. DCF and EP Model We believe that our DCF model is the most accurate prediction of the future price path for Northrop Grumman. Bringing together all of the financial statements, the DCF model gives a in depth forecast of the company. This model incorporates invested capital, ROIC, NOPLAT, and WACC. It uses NOPLAT and invested capital to find the free cash flows. We were then able to discount those cash flows back to today using the WACC and make non-operating adjustments to get the value of equity. We then divided the value of equity by the shares outstanding to get the intrinsic value. By incorporating our assumptions, we were able to arrive at our implied price of $366.19. We used


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the 10-year treasury which most recently closed at .89% to find our WACC of 4.34%. We believe this is our most reliable valuation as we had control over the research and assumptions that went into it. Dividend Discount Model We incorporated our growth assumptions into the DDM valuation to forecast future dividend payments and the rate at which they will grow. To construct our DDM we used forecasted EPS, and dividends per share for the years 2020-2024. We then were able to find our discounted cash flows using dividends per share and cost of equity. We then found the CV year (2025) cash flow using the projected EPS rather than dividends per share like the prior cash flows. By summing up these discounted cash flows for years 2020-2025 we were able to find the intrinsic value of the last FYE. To arrive at the implied price today, we used the intrinsic value in a function including cost of equity, dividend yield, and the elapsed fraction of the FY. Based on our implied price of $515.21, it is indicated that the firm is undervalued trading below its fair value and that there is a buying opportunity. However, we will not be using this model when determining our target price because the price is too high due to a high EPS in CV2025. Relative Valuation Model To conclude our valuation model, we found 6 competitors to compare Northrop Grumman to. We found each firms current and future GAAP estimated EPS and P/E to find a broad industry average. The companies used in this average were General Dynamics (GD), Lockheed Martin (LMT), Honeywell International (HON), L3Harris Technologies (LHX), and Aerojet Rocketdyne (AJRD). We chose these companies based primarily on industry, and also eliminated any outliers from our comparisons. We pulled their EPS and P/E information from FactSet and were able to find Northrop’s P/E and PEG implied relative value. We are confident in the results of this model since we

used numbers from their recently reported 2020 3rd quarter results.

Sensitivity Analysis

Beta and Equity Risk Premium Equity Risk Premium and Beta are both factors that play a major role in a company’s intrinsic value. Both factors are used in the CAPM formula to calculate the cost of equity. When the cost of equity increases, the WACC also increases which will lower the intrinsic value of the stock. The results of our sensitivity analysis prove the major role that both factors play in the intrinsic value. It is seen that as both Beta and Equity Risk Premium decrease, Northrop’s value significantly increases. This increase is directly correlated to the decrease in the cost of equity.

Risk-Free Rate and CV Growth of NOPLAT The Risk-Free Rate and the CV growth of NOPLAT are also important factors in a company’s intrinsic value. The Risk-Free Rate is also used in the CAPM formula to determine the cost of equity. Therefore, it has a similar relationship that Equity Risk Premium and Beta have on the intrinsic value of the stock. When comparing the two, we wanted to determine the severity of an impact that a slight change in the Risk-Free Rate would have on the intrinsic value without changing the CV growth rate and vice versa. The results of our sensitivity analysis on these factors show that the company has a higher sensitivity to the CV growth rate of NOPLAT than it does to the Risk-Free Rate. When moving in


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unison, the impact is not substantial. When increasing the CV growth rate, the value increases by slightly more with each increase at a growing rate.

WACC and CV ROIC The WACC and the CV ROIC have an intertwining relationship seen throughout the DCF and EP models. Since WACC is used to discount both model’s values to their present value, a higher WACC should result in a lower intrinsic value. Additionally, the CV ROIC is used in determining EP as well as the CV in both models. A higher CV ROIC should result in a higher price. Given their importance in the models, we determined that these would be excellent factors to test against each other. The results of our sensitivity analysis show that Northrop has a higher sensitivity to changes in WACC than it does to the CV ROIC. While we were not surprised by this, we were surprised at the minor size of impact that the CV ROIC had. While decreasing the CV ROIC by 6% had a larger impact on value than increasing this rate did, both directions from the current CV ROIC were miniscule in comparison to the WACC.

2020 CapEx and Effective Tax Rate CapEx and the Effective Tax Rate are two factors that we felt needed to be tested based on changes that are likely to been seen in the near future. Since Northrop is breaking further into the space segment in 2020, we felt that their CapEx will be changing in the coming years. These changes will likely be seen through investments in machinery, equipment, and new software needed for additional production. With Joe Biden winning the 2020 Presidential race, the Corporate Tax Rate on businesses is likely to change. This in turn will affect Northrop’s Effective Rate. We wanted to test these factors to determine the size of impact they will have on the company in future years. Our results showed that Northrop’s intrinsic value is quite sensitive to these changes. Even without changing CapEx, an increase in the Effective Tax Rate could lead to a potential $50 decrease in the stock’s value.

Annual Product and Service Cost as a % of Sales These factors have an immense impact on the value of the company. They Play an important role in determining Net Income which is heavily factored into both the DCF and EP Models. We wanted to determine the size of impact that would be seen by changing the percentage cost that each year takes into its forecast calculation. Our results show how major of a role these factors are on the company’s value. Changing either factor by half of a percent results in a major change in the stock’s value. This shows the importance for Northrop to continue keeping its’ costs as low as possible.


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Pre-Tax Cost of Debt and Marginal Tax Rate The Pre-Tax Cost of Debt and the Marginal Tax Rate are both factored into the After-Tax Cost of Debt. Since this is then calculated into WACC, we decided these would be good factors to test against each other. As mentioned earlier, with Joe Biden winning the 2020 Presidential Race, the Corporate Tax Rate is likely to increase. This is one of the primary reasons we chose to test these factors. The results of our severity test were slightly surprising to us. We had expected the value to move at those levels with changes in the Pre-Tax Cost of Debt. However, we expected greater sensitivity to changes in the Marginal Tax Rate.


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Important Disclaimer This report was created by students enrolled in the Security Analysis (6F:112) class at the University of Iowa. The report was originally created to offer an internal investment recommendation for the University of Iowa Krause Fund and its advisory board. The report also provides potential employers and other interested parties an example of the students’ skills, knowledge and abilities. Members of the Krause Fund are not registered investment advisors, brokers or officially licensed financial professionals. The investment advice contained in this report does not represent an offer or solicitation to buy or sell any of the securities mentioned. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Krause Fund may hold a financial interest in the companies mentioned in this report.


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6 DOD Releases Fiscal Year 2021 Budget Proposal. (2020, February 10). Retrieved November 16, 2020, from https://www.defense.gov/Newsroom/Releases/Release/Article/2079489/dod-releases-fiscal-year-2021-budget-proposal/

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10 Mehta, A., & Gould, J. (2020, November 08). Where President-elect Joe Biden stands on national security issues. Retrieved November 16, 2020, from https://www.defensenews.com/pentagon/2020/11/07/where-president-elect-joe-biden-stands-on-national-security-issues/

11 Northrop Grumman 10Q Q1 2020. (2020, April 29). Retrieved 2020, from https://investor.northropgrumman.com/static-files/b2eafbd3-e8c6-4f26-8de0-92fa5bbf11c8

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15 Smialek, J. (2020, September 16). Fed Pledges Low Rates for Years, and Until Inflation Picks Up. Retrieved November 16, 2020, from https://www.nytimes.com/2020/09/16/business/economy/federal-reserve-interest-rates.html

16 Werner, B. (2020, May 04). SECDEF Esper Preparing For Future Defense Spending Cuts. Retrieved November 16, 2020, from https://news.usni.org/2020/05/04/secdef-esper-preparing-for-future-defense-spending-cuts

Northrup Grumman

Revenue Decomposition

Fiscal Years Ending Dec. 31 2017 2018 2019 2020E 2021E 2022E 2023E 2024E 2025CV

Aerospace Systems

Product 10,064 11,087 11,778 12,249 12,739 13,058 13,319 13,585 13,857

Growth % 13.49% 10.16% 6.23% 4.00% 4.00% 2.50% 2.00% 2.00% 2.00%

Service 2,067 2,009 2,084 2,105 2,126 2,143 2,156 2,167 2,177

Growth % 5.46% -2.81% 3.73% 1.00% 1.00% 0.80% 0.60% 0.50% 0.50%

Total 12,131 13,096 13,862 14,354 14,865 15,200 15,474 15,752 16,034

Growth % 12.03% 7.95% 5.85% 3.78% 3.64% 2.26% 1.80% 1.79% 1.79%

Innovation Systems

Product - 2,894 5,467 5,658 5,715 5,772 5,830 5,874 5,903 Growth % 0.00% 0.00% 88.91% 3.50% 1.00% 1.00% 1.00% 0.75% 0.50%Service - 382 652 685 691 698 705 711 714 Growth % 0.00% 0.00% 70.68% 5% 1.00% 1.00% 1.00% 0.75% 0.50%Total - 3,276 6,119 6,343 6,406 6,470 6,535 6,584 6,617

Growth % 0.00% 0.00% 86.78% 3.66% 1.00% 1.00% 1.00% 0.75% 0.50%Mission Systems

Product 7,012 7,329 7,711 8,097 8,501 8,841 9,195 9,563 9,706 Growth % 8.36% 4.52% 5.21% 5.00% 5.00% 4.00% 4.00% 4.00% 1.50%Service 4,458 4,380 4,552 4461 4361 4252 4145 4062 4022Growth % 0.02% -1.75% 3.93% -2.00% -2.25% -2.50% -2.50% -2.00% -1%Total 11,470 11,709 12,263 12,558 12,862 13,093 13,340 13,625 13,728

Growth % 4.96% 2.08% 4.73% 2.40% 2.42% 1.80% 1.89% 2.14% 0.75%

Technology Services

Product 391 485 554 573 593 611 623 630 636 Growth % 22.19% 24.04% 14.23% 3.50% 3.50% 3.00% 2.00% 1.00% 1.00%Service 4,296 3,812 3,556 3,556 3,556 3,556 3,556 3,556 3,556 Growth % -4.64% -11.27% -6.72% -3.00% -2.50% -2.00% -2.00% -1.00% -1.00%Total 4,687 4,297 4,110 4,129 4,149 4,167 4,179 4,186 4,192

Growth % -2.86% -8.32% -4.35% 0.47% 0.49% 0.43% 0.29% 0.15% 0.15%

Total Revenues

Total Net Sales: 28,288 32,378 36,354 37,384 38,283 38,931 39,529 40,147 40,571

Growth % 6.42% 14.46% 12.28% 2.83% 2.40% 1.69% 1.54% 1.56% 1.06%

Total Product Sales 17,467 21,795 25,510 26,577 27,549 28,282 28,967 29,651 30,102

Total Serivice Sales 10,821 10,583 10,844 10,806 10,734 10,649 10,562 10,496 10,469

Segment Breakdown (%of Total Sales)

Aerospace Systems 42.88% 40.45% 38.13% 38.40% 38.83% 39.04% 39.15% 39.24% 39.52%

Innovation Systems 0.00% 10.12% 16.83% 16.97% 16.73% 16.62% 16.53% 16.40% 16.31%

Mission Systems 40.55% 36.16% 33.73% 33.59% 33.60% 33.63% 33.75% 33.94% 33.84%

Technology Services 16.57% 13.27% 11.31% 11.05% 10.84% 10.70% 10.57% 10.43% 10.33%

Total: 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Northrup Grumman

Income Statement


Sales

Product 16,038$ 20,469$ 23,852$ 26,577$ $ 27,549 $ 28,282 $ 28,967 $ 29,651 $ 30,102

Service 9,765 9,626 9,989 10,806 10,734 10,649 10,562 10,496 10,469

Total Sales 25,803 30,095 33,841 37,384 38,283 38,931 39,529 40,147 40,571

Operating costs and expenses

Product 12,271 14,985 17,657 19,494 20,206 20,744 21,246 21,748 22,079

Service 7,578 7,519 7,907 8,493 8,436 8,370 8,302 8,249 8,228

Depreciation & Amortization expenses 475 800 1,018 1,006 1,005 1,050 980 1,001 1,028

Depreciation Expense 461 597 686 744 801 853 902 946 988

Amortization Expense 14 203 332 262 204 197 78 55 40

General and administrative expenses 2,655 3,011 3,290 3,828 3,920 3,986 4,047 4,110 4,154

Operating Income 2,824 3,780 3,969 4,563 4,716 4,781 4,955 5,038 5,082

Other (expense) income

Interest Expense (360) (562) (528) (289) (265) (249) (239) (249) (230)

Pension Benefit (Expense) 1,235 394 (1,000) - - - - - - Other, net 136 130 107 124 120 117 121 119 119

Earnings before income taxes 3,835 3,742 2,548 4,398 4,571 4,649 4,836 4,908 4,971

Federal and Foreign income tax expense 1,034 513 300 875 910 925 962 977 989

Net Earnings (loss) 2,801$ 3,229$ 2,248$ 3,523$ 3,661$ 3,724$ 3,874$ 3,931$ 3,982$

Basic earning per share 11.55 18.59 13.28 20.99 22.17 22.87 24.09 24.72 25.27

Weighted-average common shares outstanding, in millions 174.4 173.7 169.3 166 164 162 160 158 157

Dividends Per Share 3.90 4.70 5.16 5.63 6.15 6.58 6.59 6.51 6.51

Dividends paid 680 816 874 937 1,008 1,064 1,053 1,030 1,022

Northrup Grumman

Balance Sheet


Assets

Cash & cash equivalents 11,225 1,579 2,245 1,675 563 733 1,330 3,001 3,527

Accounts receivable, net 3,976 1,448 1,326 1,450 1,586 1,734 1,896 2,074 2,268

Unbilled receivables, net - 5,026 5,334 5,735 6,166 6,630 7,129 7,665 8,241

Inventoried costs, net 780 654 783 805 827 850 874 898 923

Prepaid expenses & other current assets 368 973 997 1,018 1,039 1,061 1,084 1,107 1,130

Total current assets 16,349 9,680 10,685 10,683 10,182 11,009 12,312 14,745 16,089

Property, plant & equipment, net 4,225 6,372 6,912 7,439 7,925 8,374 8,791 9,178 9,540

Operating lease right-of-use assets 1,162 1,795 1,511 1,626 1,733 1,831 1,922 2,006 2,085

Goodwill 12,455 18,672 18,708 18,708 18,708 18,708 18,708 18,708 18,708

Intangible assets, net - 1,372 1,040 778 574 377 299 244 204 Deferred tax assets 475 94 508 523 538 553 569 585 602 Other non-current assets 1,413 1,463 1,725 1,800 1,877 1,958 2,043 2,131 2,224 Total assets 34,917 37,653 41,089 41,557 41,536 42,811 44,644 47,598 49,452 Trade accounts payable 1,661 2,182 2,226 1,670 1,777 1,892 2,015 2,145 2,283

Accrued employee compensation 1,382 1,676 1,865 1,966 2,072 2,185 2,303 2,428 2,559

Advance payments & amounts in excess of costs incurred 1,617 1,917 2,237 2,380 2,531 2,692 2,864 3,047 3,241

ST Debt 867 517 1,109 1,000 700 1,500 1,050 1,500 527

Other current liabilities 2,305 2,499 1,997 2,135 2,282 2,440 2,608 2,788 2,980

Total current liabilities 6,965 8,274 9,434 9,150 9,363 10,709 10,840 11,907 11,590

Long-term debt, net of current portion 14,399 13,883 12,770 11,660 10,918 9,413 9,410 9,407 9,532

Pension & other post-retirement benefit plan liabilities 5,511 5,755 6,979 7,188 5,751 5,176 4,658 4,192 3,773

Operating lease liabilities - - 1,308 1,408 1,500 1,585 1,664 1,737 1,805

Other non-current liabilities 994 1,446 1,779 1,856 1,936 2,020 2,107 2,198 2,293

Total liabilities 27,869 29,466 32,270 31,262 29,468 28,902 28,678 29,441 28,994

Common Equity 218 171 168 309 618 927 1236 1544 1853

Retained earnings 11,548 8,068 8,748 10,083 11,548 13,079 14,827 16,709 18,701

Accumulated other comprehensive income (loss) (4,718) (52) (97) (97) (97) (97) (97) (97) (97)

Total shareholders' equity 7,048 8,187 8,819 10,295 12,069 13,909 15,965 18,156 20,458

Total liabilities and shareholders' equity 34,917 37,653 41,089 41,557 41,536 42,811 44,644 47,598 49,452

Northrup Grumman

Historical Cash Flow Statement

in MillionsFiscal Years Ending Dec. 31 2015 2016 2017 2018 2019

Operating Activities

Net earnings (loss) 1,990 2,200 2,015 3,229 2,248

Depreciation & amortization 467 456 475 800 1,018

Mark-to-market pension & OPEB Benefit - - - 655 1,800

Non-cash lease expense - - - 247

Stock-based compensation 99 93 94 86 127

Deferred income taxes 36 603 234 (509)

Accounts receivable, net (30) (461) (677) 202 122

Unbilled receivables, net - - - (297) (335)

Inventoried costs, net (80) (15) 36 (37) (135)

Prepaid expenses & other assets 43 (110) (81) (56) (78)

Accounts payable & other liabilities (632) 198 539 381 617 Income taxes payable 135 148 (157) (258) (63) Retiree benefits (263) 393 (191) (1,083) (703) Other assets & liabilities, net (36) (125) (43) (29) (59)

Net cash flows from operating activities 2,162 2,813 2,613 3,827 4,297

Acquisition of Orbital ATK, net of cash acquired - - - (7,657) -

Capital expenditures (471) (920) (928) (1,249) (1,264)

Other investing activities, net 40 115 39 28 57

Net cash flows from investing activities (431) (805) (889) (8,878) (1,207)

Common stock repurchases (3,182) (1,547) (393) (1,263) (744)

Net proceeds from issuance of long-term debt 600 749 8,245 - -

Payments of long-term debt - (321) - (2,276) (500)

Net (payments to) proceeds from credit facilities - - (13) (320) (31)

Net (repayments of) borrowings on commercial paper - - - 198 (198)

Cash dividends paid (603) (640) (689) (821) (880)

Payments of employee taxes withheld from share-based awards - (153) (92) (85) (65)

Net proceeds from credit facilities - 135 - - -

Other financing activities, net (90) (9) (98) (28) (6)

Net cash flows from financing activities (3,275) (1,786) 6,960 (4,595) (2,424)

Increase (decrease) in cash & cash equivalents (1,544) 222 8,684 (9,646) 666

Cash & cash equivalents, beginning of year 3,863 2,319 2,541 11,225 1,579

Cash & cash equivalents, end of year (2,245) 2,541 11,225 1,579 2,245

Northrup Grumman

Forecasted Cash Flow Statement

Fiscal Years Ending Dec. 31 2020E 2021E 2022E 2023E 2024E 2025CV

Operating Activities

Net Income (loss) 3523 3661 3724 3874 3931 3982

Adjustments to reconcile NI:

Depreciation & Amortization 1,006 1,005 1,050 980 1,001 1,028

Depreciation 744 801 853 902 946 988

Amortization 262 204 197 78 55 40

Pension benefit (loss) 209 (1,438) (575) (518) (466) (419)

Changes in Working Cap Accounts:

Accounts Receivable (124) (136) (148) (162) (177) (194)

Unbilled Recievables (401) (431) (464) (499) (536) (576)

Inventories (22) (22) (23) (24) (24) (25)

Prepaid Expenses (21) (21) (22) (22) (23) (23)

Trade Accounts Payable (557) 108 115 122 130 139

Defered Tax Assets (15) (15) (15) (16) (16) (17)

Operating Lease Liabilities 100 92 85 79 73 68

Operating Lease Assets (115) (106) (98) (91) (85) (79)

Other non-current liabilites 77 80 84 87 91 95

Other Current Liabilities 138 147 157 168 180 192

Accrued Compensation 101 106 112 118 125 131

Advance Payments 143 152 161 172 182 194

Net Cash Flows from Operating Activities 4,042 3,182 4,143 4,269 4,387 4,496

Investing Activities

CapEX (1,272) (1,287) (1,302) (1,318) (1,334) (1,350)

Intangible Assets - - - - - -

Other LT Assets (75) (78) (81) (85) (88) (92)

Net Cash used for investing activities (1,346) (1,365) (1,383) (1,403) (1,422) (1,442)

Financing Activities

Repurchase of Common Stock (1,251) (1,188) (1,129) (1,073) (1,019) (968)

Current Portion of ST Debt (109) (300) 800 (450) 450 (973)

Common Stock 141 309 309 309 309 309

Long-term Debt (1,110) (742) (1,505) (3) (3) 125

Common stock dividends paid (937) (1,008) (1,064) (1,053) (1,030) (1,022)

Net cash provided by financing activities (3,266) (2,929) (2,589) (2,270) (1,293) (2,529)

Increase (Decrease) in cash & cash equivalents (570) (1,112) 171 596 1,672 526

Cash & cash equivalents, beg of yeat 2,245 1,675 563 733 1,330 3,001

End of the Year Cash Balance 1,675 563 733 1,330 3,001 3,527

Northrup Grumman

Common Size Income Statement

Fiscal Years Ending Dec. 31 2017 2018 2019 2020E 2021E 2022E 2023E 2024E 2025E

Sales

Product 62.16% 68.01% 70.48% 71.09% 71.96% 72.65% 73.28% 73.86% 74.20%

Service 37.84% 31.99% 29.52% 28.91% 28.04% 27.35% 26.72% 26.14% 25.80%

Total Sales 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Operating costs and expenses

Product 47.56% 49.79% 52.18% 52.14% 52.78% 53.28% 53.75% 54.17% 54.42%

Service 29.37% 24.98% 23.37% 22.72% 22.04% 21.50% 21.00% 20.55% 20.28%

Depreciation & Amortization expenses 1.84% 2.66% 3.01% 2.69% 2.62% 2.70% 2.48% 2.49% 2.53%

Depreciation Expense 1.79% 1.98% 2.03% 1.99% 2.09% 2.19% 2.28% 2.36% 2.44%

Amortization Expense 0.05% 0.67% 0.98% 0.70% 0.53% 0.51% 0.20% 0.14% 0.10%

General and administrative expenses 10.29% 10.00% 9.72% 10.24% 10.24% 10.24% 10.24% 10.24% 10.24%

Operating Income 10.94% 12.56% 11.73% 12.21% 12.32% 12.28% 12.53% 12.55% 12.53%

Other (expense) income

Interest Expense -1.40% -1.87% -1.56% -0.77% -0.69% -0.64% -0.60% -0.62% -0.57%

Pension Benefit (Expense) 4.79% 1.31% -2.95% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Other, net 0.53% 0.43% 0.32% 0.33% 0.31% 0.30% 0.31% 0.30% 0.29%

Earnings before income taxes 14.86% 12.43% 7.53% 11.77% 11.94% 11.94% 12.24% 12.23% 12.25%

Federal and Foreign income tax expense 4.01% 1.70% 0.89% 2.34% 2.38% 2.38% 2.43% 2.43% 2.44%

Net Earnings (loss) 10.86% 10.73% 6.64% 9.42% 9.56% 9.57% 9.80% 9.79% 9.82%

Northrup Grumman

Common Size Balance Sheet


Assets

Cash & cash equivalents 43.50% 5.25% 6.63% 4.48% 1.47% 1.88% 3.36% 7.48% 8.69%Accounts receivable, net 15.41% 4.81% 3.92% 3.88% 4.14% 4.45% 4.80% 5.17% 5.59%Unbilled receivables, net 0.00% 16.70% 15.76% 15.34% 16.11% 17.03% 18.03% 19.09% 20.31%Inventoried costs, net 3.02% 2.17% 2.31% 2.15% 2.16% 2.18% 2.21% 2.24% 2.28%Prepaid expenses & other current assets 1.43% 3.23% 2.95% 2.72% 2.72% 2.73% 2.74% 2.76% 2.79%

Total current assets 63.36% 32.16% 31.57% 28.58% 26.60% 28.28% 31.15% 36.73% 39.66%

Property, plant & equipment, net 16.37% 21.17% 20.42% 19.90% 20.70% 21.51% 22.24% 22.86% 23.51%

Operating lease right-of-use assets 4.50% 5.96% 4.46% 4.35% 4.53% 4.70% 4.86% 5.00% 5.14%

Goodwill 48.27% 62.04% 55.28% 50.04% 48.87% 48.05% 47.33% 46.60% 46.11%

Intangible assets, net 0.00% 4.56% 3.07% 2.08% 1.50% 0.97% 0.76% 0.61% 0.50%Deferred tax assets 1.84% 0.31% 1.50% 1.40% 1.40% 1.42% 1.44% 1.46% 1.48%Other non-current assets 5.48% 4.86% 5.10% 4.81% 4.90% 5.03% 5.17% 5.31% 5.48%Total assets 135.32% 125.11% 121.42% 111.16% 108.50% 109.97% 112.94% 118.56% 121.89%Trade accounts payable 6.44% 7.25% 6.58% 4.47% 4.64% 4.86% 5.10% 5.34% 5.63%

Accrued employee compensation 5.36% 5.57% 5.51% 5.26% 5.41% 5.61% 5.83% 6.05% 6.31%

Advance payments & amounts in excess of costs incurred 6.27% 6.37% 6.61% 6.37% 6.61% 6.92% 7.25% 7.59% 7.99%

Other current liabilities 8.93% 8.30% 5.90% 5.71% 5.96% 6.27% 6.60% 6.94% 7.35%

Total current liabilities 26.99% 27.49% 27.88% 24.48% 24.46% 27.51% 27.42% 29.66% 28.57%

Long-term debt, net of current portion 55.80% 46.13% 37.74% 31.19% 28.52% 24.18% 23.81% 23.43% 23.49%

Pension & other post-retirement benefit plan liabilities 21.36% 19.12% 20.62% 19.23% 15.02% 13.29% 11.78% 10.44% 9.30%

Operating lease liabilities 0.00% 0.00% 3.87% 3.77% 3.92% 4.07% 4.21% 4.33% 4.45%

Other non-current liabilities 3.85% 4.80% 5.26% 4.96% 5.06% 5.19% 5.33% 5.48% 5.65%

Total liabilities 108.01% 97.91% 95.36% 83.62% 76.97% 74.24% 72.55% 73.33% 71.46%

Common stock 0.84% 0.57% 0.50% 0.83% 1.61% 2.38% 3.13% 3.85% 4.57%

Retained earnings 44.75% 26.81% 25.85% 26.97% 30.17% 33.60% 37.51% 41.62% 46.10%

Accumulated other comprehensive income (loss) -18.28% -0.17% -0.29% -0.26% -0.25% -0.25% -0.25% -0.24% -0.24%

Total shareholders' equity 27.31% 27.20% 26.06% 27.54% 31.53% 35.73% 40.39% 45.23% 50.42%

Total liabilities and shareholders' equity 135.32% 125.11% 121.42% 111.16% 108.50% 109.97% 112.94% 118.56% 121.89%

Northrup Grumman

Value Driver Estimation


NOPLAT: 1,577 4,066 2,803 2,983 3,020 2,995 3,048 3,019 2,951

Net Sales 25,803 30,095 33,841 37,384 38,283 38,931 39,529 40,147 40,571

- COGS 12,271 14,985 17,657 19,494 20,206 20,744 21,246 21,748 22,079

-Depreciation & Amortization Expenses 475 800 1,018 1,006 1,005 1,050 980 1,001 1,028

- Operating Expenses 7,578 7,519 7,907 8,493 8,436 8,370 8,302 8,249 8,228

- SG&A 2,655 3,011 3,290 3,828 3,920 3,986 4,047 4,110 4,154

Environmental Matters + Litigation 410 461 649 714 785 864 950 1,045 1,150

+ Implied Interest on Operating Leases 24 34 52 52 52 52 52 52 52

EBITA 2,438 3,353 3,372 3,901 3,982 3,969 4,056 4,044 3,984

Effective Income Tax Rate 35.00% 20.60% 19.90% 19.90% 26.90% 26.90% 26.90% 26.90% 26.90%

Provision for Income Taxes 1,030 710 782 875 910 925 962 977 989

+ Tax Shield on Interest Expense (126) (116) (105) (58) (71) (67) (64) (67) (62)

- Tax on Pension Benefit (Expense) 432 81 (199) - - - - - - - Tax on Other income (expense), net 48 27 21 25 32 32 32 32 32 + Tax Shield on Implied Lease Interest 8 7 10 10 14 14 14 14 14 Total Adjusted Taxes 1,549 887 677 918 962 975 1,008 1,026 1,033 Deferred Tax Liability 1,708 108 - - - - - - - Change in Deferred Taxes (688) (1,600) (108) - - - - - -

Invested Capital (IC): 6,786 12,484 12,198 13,716 14,490 15,235 15,962 16,679 17,387

Current Operating Assets:

Normal Cash 516 602 677 748 766 779 791 803 811

Accounts Recievable, Net 3,976 1,448 1,326 1,450 1,586 1,734 1,896 2,074 2,268

Unbilled Recievables - 5,026 5,334 5,735 6,166 6,630 7,129 7,665 8,241

Inventoried costs 780 654 783 805 827 850 874 898 923 Prepaid expenses & other current assets 368 973 997 1,018 1,039 1,061 1,084 1,107 1,130

Total Current Operating Assets 5,640 8,703 9,117 9,756 10,384 11,054 11,773 12,546 13,374

Current Operating Liabilities:

Accounts Payable 1,661 2,182 2,226 1,670 1,777 1,892 2,015 2,145 2,283

Accrued Expenses 2,999 3,593 4,102 4,346 4,604 4,877 5,167 5,474 5,800

Total Current Operating Liabilities 4,660 5,775 6,328 6,015 6,381 6,769 7,182 7,619 8,083

Net Operating Working Capital 980 2,928 2,789 3,741 4,003 4,285 4,592 4,927 5,290

Plus: Net PPE 4,225 6,372 6,912 7,439 7,925 8,374 8,791 9,178 9,540

Other LT Operating Assets 2,575 4,630 4,276 4,391 4,498 4,596 4,687 4,771 4,850

Plus: PV of Operating Leases 1,162 1,795 1,511 1,626 1,733 1,831 1,922 2,006 2,085

Intangible assets, net - 1,372 1,040 1,040 1,040 1,040 1,040 1,040 1,040 Other non-current assets 1,413 1,463 1,725 1,725 1,725 1,725 1,725 1,725 1,725

Other LT operating liabilities 994 1,446 1,779 1,856 1,936 2,020 2,107 2,198 2,293

Free Cash Flow (FCF):

NOPLAT 1,577 4,066 2,803 2,983 3,020 2,995 3,048 3,019 2,951

Change in IC 1,534 5,698 (286) 1,518 775 745 727 717 709

FCF 43 (1,632) 3,089 1,465 2,245 2,249 2,321 2,302 2,242

Return on Invested Capital (ROIC):

NOPLAT 1,577 4,066 2,803 2,983 3,020 2,995 3,048 3,019 2,951

Beg. IC 5,252 6,786 12,484 12,198 13,716 14,490 15,235 15,962 16,679

ROIC 30% 60% 22% 24% 22% 21% 20% 19% 18%

Economic Profit (EP):

Beg. IC 5,252 6,786 12,484 12,198 13,716 14,490 15,235 15,962 16,679

x (ROIC - WACC) 26% 56% 18% 20% 18% 16% 16% 15% 13%

EP 1,349 3,771 2,261 2,453 2,425 2,366 2,387 2,326 2,227

Northrup Grumman

Weighted Average Cost of Capital (WACC) Estimation

Cost of Equity: ASSUMPTIONS:

Risk-Free Rate 0.89% 10-year Treasury Bond

Beta 0.77 5 Year Weekly Avg of Beta

Equity Risk Premium 5.29% Damodoran's ERP 1961-October 1, 2020

Cost of Equity 4.96%

Cost of Debt:

Risk-Free Rate 0.89% 10-year Treasury Bond

Implied Default Premium 2.00%

Pre-Tax Cost of Debt 2.89% YTM on NOC's 2030 Corporate Bond

Marginal Tax Rate 21%

After-Tax Cost of Debt 2.28%

Market Value of Common Equity: MV Weights

Total Shares Outstanding 169.3

Current Stock Price $312.74

MV of Equity 52,946.88 76.68%

Market Value of Debt:

Short-Term Debt 1,109

Current Portion of LTD 500

Long-Term Debt 12,770

PV of Operating Leases 1,724

MV of Total Debt 16,103.09 23.32%

Market Value of the Firm 69,049.97 100.00%

Estimated WACC 4.34%

Fiscal Years Ending Dec. 31 2020E 2021E 2022E 2023E 2024E 2025E

DCF Model:

Free Cash Flow (FCF) 1464.9 2244.9 2249.5 2321.4 2302.2 2242.4

Continuing Value (CV) 83386.9

PV of FCF 1404.0 2062.1 1980.3 1958.6 1861.7 67431.7

Value of Operating Assets: 76698.5

Non-Operating Adjustments

Excess Cash 1251.0

Non Current Assets 1725.0

Non Operating Liability -6979.0

Debt -13160.0

ESOP -194.9

Value of Equity 59340.6

Shares Outstanding 166.4

Intrinsic Value of Last FYE 356.59$

Implied Price as of Today 366.19$

EP Model:

Economic Profit (EP) 2453.4 2424.6 2365.9 2387.0 2326.1 2227.4

Continuing Value (CV) 66708.3

PV of EP 2351.3 2227.1 2082.8 2014.0 1881.1 53944.3

Total PV of EP 64500.7

Invested Capital (last FYE) 12197.8

Value of Operating Assets: 76698.5

Non-Operating Adjustments

Excess Cash 1251.0

Non Current Assets 1725.0

Non Operating Liability -6979.0

Debt -13160.0

ESOP -194.9

Value of Equity 59340.6

Shares Outstanding 166.4

Intrinsic Value of Last FYE 356.59$

Implied Price as of Today 366.19$

Northrup Grumman

Dividend Discount Model (DDM) or Fundamental P/E Valuation Model

Fiscal Years Ending Dec. 31 2020E 2021E 2022E 2023E 2024E 2025E

EPS 20.99$ 22.17$ 22.87$ 24.09$ 24.72$ 25.27$

Key Assumptions

CV growth of EPS 1.00%

CV Year ROE 19.47%

Cost of Equity 4.96%

Future Cash Flows

P/E Multiple (CV Year) 23.93

EPS (CV Year) 25.27$

Future Stock Price 604.61$

Dividends Per Share 5.63 6.15 6.58 6.59 6.51

Discounted Cash Flows 5.36 5.58 5.69 5.43 5.11 474.53

Intrinsic Value as of Last FYE 501.71$ Implied Price as of Today 515.21$

Northrup Grumman

Relative Valuation Models

EPS EPS Est. 5yr

Ticker Company Price 2020E 2021E P/E 20 P/E 21 EPS gr. PEG 20 PEG 21

GD General Dynamics $130.84 $11.07 $11.59 11.80 11.30 3.6 3.30 3.16

LMT Lockheed Martin $348.81 $24.55 $26.21 14.20 13.30 8.1 1.75 1.64

HON Honeywell International Inc. $199.45 $6.89 $7.90 28.60 25.50 2.1 13.49 12.03

LHX L3Harris Technologies $194.08 $6.45 10.84 13.90 12.30 13.4 0.81 0.92 AJRD Aerojet Rocketdyne Holdings $32.24 $1.77 $1.99 18.21 16.20 5.1 3.61 3.21

Average 17.34 15.72 4.59 4.19

NOR

THR Northrup Grumman $312.74 $20.99 $22.17 14.9 14.1 13.23 1.1 1.1

Implied Relative Value:

P/E (EPS20) $ 364.00

P/E (EPS21) 348.49$

PEG (EPS20) 1,274.42$

PEG (EPS21) 1,228.61$

Northrup Grumman

Key Management Ratios


Liquidity Ratios:

Quick Ratio 2.24 1.09 1.05 1.08 1.00 0.95 1.06 1.16 1.31

((CA-Inv.)/CL)

Current Ratio 2.35 1.17 1.13 1.17 1.09 1.03 1.14 1.24 1.39

(CA/CL)

Operating Cash Flow Ratio 0.38 0.46 0.46 0.44 0.34 0.39 0.39 0.37 0.39

(Op. CF./CL)

Asset-Management Ratios:

Total Asset Turnover 0.18 0.19 0.20 0.22 0.23 0.22 0.21 0.21 0.41

((Total Sales/(Beg. Assets + End Assets))/2)

Inventory Days Ratio 14.34 10.61 11.18 10.50 10.54 10.66 10.80 10.93 11.12

((Inv.*365)/COGS)

A/R Turnover 7.09 11.10 24.40 26.93 25.22 23.45 21.78 20.22 18.69

(Sales/Avg. A/R)

Financial Leverage Ratios:

Debt to Equity Ratio 3.95 3.60 3.66 3.04 2.44 2.08 1.80 1.62 1.42

(Total Liabilities/Shareholders Equity)

Debt Ratio 0.80 0.78 0.79 0.75 0.71 0.68 0.64 0.62 0.59

(Total Liabilities/Total Assets)

Equity Ratio 0.20 0.22 0.21 0.25 0.29 0.32 0.36 0.38 0.41

(Total Equity/Total Assets)

Profitability Ratios:

Gross Profit Margin 23.07% 25.22% 24.46% 25.14% 25.18% 25.22% 25.25% 25.28% 25.30%

((Revenue-COGS)/Revenue*100%)

Net Profit Margin 10.86% 10.73% 6.64% 9.42% 9.56% 9.57% 9.80% 9.79% 9.82%

(NI/Revenue)

ROE 39.74% 39.44% 25.49% 34.22% 30.34% 26.78% 24.26% 21.65% 19.47%

(NI/Total Shareholders Equity)

Payout Policy Ratios:

Dividend Payout Ratio 33.77% 25.28% 38.86% 26.82% 27.74% 28.77% 27.35% 26.34% 25.77%

(Dividend/EPS)

Total Payout Ratio 38.31% 64.40% 71.96% 62.10% 59.99% 58.89% 54.88% 52.13% 49.96%

((Divs. + Repurchases)/NI)

P/E Ratio 27.08 16.82 23.55 14.90 14.11 13.67 12.98 12.65 12.38

Northrup Grumman

Valuation of Options Granted under ESOP

Current Stock Price $312.74

Risk Free Rate 0.89%

Current Dividend Yield 1.90%

Annualized St. Dev. of Stock Returns 30.24%

Average Average B-S Value

Range of Number Exercise Remaining Option of Options

Outstanding Options of Shares Price Life (yrs) Price Granted

Range 1 0.701 278.00 0.90 81.03$ 194.878$

total 0.701 278.00$ 0.90 81.07$ 194.878$

Northrup Grumman

Effects of ESOP Exercise and Share Repurchases on Common Stock Account and Number of Shares Outstanding

Number of Options Outstanding (shares): 1

Average Time to Maturity (years): 0.90

Expected Annual Number of Options Exercised: 1

Current Average Strike Price: 278.00$

Cost of Equity: 4.83%

Current Stock Price: $312.74

Fiscal Years Ending Dec. 31 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E

Increase in Shares Outstanding: 1 1 1 1 1 1 1 1 1 1

Average Strike Price: 278.00$ 278.00$ 278.00$ 278.00$ 278.00$ 278.00$ 278.00$ 278.00$ 278.00$ 278.00$

Increase in Common Stock Account: 309 309 309 309 309 309 309 309 309 309

Change in Treasury Stock 1,251 1,188 1,129 1,073 1,019 968 0 0 0 0

Expected Price of Repurchased Shares: 312.74$ 327.85$ 343.68$ 360.28$ 377.68$ 395.92$ 415.05$ 435.09$ 456.11$ 478.14$

Number of Shares Repurchased: 4 4 3 3 3 2 - - - -

Shares Outstanding (beginning of the year) 169 166 164 162 160 158 157 158 159 160

Plus: Shares Issued Through ESOP 1 1 1 1 1 1 1 1 1 1

Less: Shares Repurchased in Treasury 4 4 3 3 3 2 - - - -

Shares Outstanding (end of the year) 166 164 162 160 158 157 158 159 160 161

Northrup Grumman

Sensitivity Tables

366.19 0.62 0.67 0.72 0.77 0.82 0.87 0.92

4.99% 503.74 461.69 425.02 392.77 364.18 338.65 315.72

5.09% 492.72 451.36 415.30 383.59 355.48 330.38 307.84 5.19% 482.09 441.39 405.92 374.73 347.08 322.41 300.24

5.29% 471.83 431.78 396.87 366.19 338.99 314.72 292.92

5.39% 461.92 422.49 388.14 357.94 331.17 307.29 285.84

5.49% 452.34 413.51 379.69 349.97 323.63 300.12 279.01 5.59% 443.08 404.84 371.53 342.26 316.33 293.19 272.41

366.19 0.74% 0.79% 0.84% 0.89% 0.94% 0.99% 1.04%

0.55% 340.44 335.78 331.21 326.65 322.35 318.05 313.84

0.70% 353.49 348.50 343.62 338.74 334.16 329.57 325.08 0.85% 367.70 362.34 357.10 351.87 346.96 342.05 337.25

1% 383.24 377.46 371.81 366.19 360.90 355.63 350.48

1.15% 400.29 394.03 387.92 381.84 376.14 370.46 364.91

1.30% 419.08 412.28 405.64 399.05 392.87 386.71 380.71 1.45% 439.92 432.47 425.23 418.04 411.31 404.61 398.09

366.19 4.04% 4.14% 4.24% 4.34% 4.44% 4.54% 4.64%

11.69% 399.97 383.40 367.86 353.39 339.49 326.51 314.24

13.69% 406.11 389.32 373.56 358.90 344.81 331.65 319.22 15.69% 410.68 393.73 377.82 363.01 348.78 335.49 322.94

17.69% 414.23 397.14 381.11 366.19 351.85 338.46 325.81

19.69% 417.05 399.86 383.73 368.72 354.29 340.83 328.10

21.69% 419.35 402.07 385.87 370.78 356.29 342.75 329.97 23.69% 421.26 403.92 387.64 372.50 357.95 344.36 331.52

366.19$ 957 1,057 1,157 1,257 1,357 1,457 1,557

13.90% 447.86 438.04 428.22 418.45 408.58 398.76 388.95

15.90% 430.01 420.33 410.66 401.03 391.31 381.63 371.96 17.90% 412.15 402.62 393.09 383.61 374.03 364.50 354.97

19.90% 394.29 384.91 375.52 366.19 356.76 347.37 337.99

21.90% 376.43 367.20 357.96 348.76 339.48 330.24 321.00

23.90% 358.58 349.48 340.39 331.34 322.20 313.11 304.02 25.90% 340.72 331.77 322.82 313.92 304.93 295.98 287.03

366.19$ 71.85% 72.35% 72.85% 73.35% 73.85% 74.35% 74.85%

77.10% 451.53 430.45 409.36 388.41 367.19 346.11 325.02

77.60% 444.10 423.02 401.94 380.98 359.77 338.68 317.60 78.10% 436.68 415.59 394.51 373.55 352.34 331.25 310.17

78.60% 429.31 408.23 387.14 366.19 344.97 323.89 302.80

79.10% 421.82 400.74 379.65 358.70 337.48 316.40 295.31

79.60% 414.39 393.31 372.22 351.27 330.06 308.97 287.89 80.10% 406.97 385.88 364.80 343.84 322.63 301.54 280.46

366.19$ 3.79% 3.49% 3.19% 2.89% 2.59% 2.29% 1.99%

15.00% 336.52 344.12 351.98 360.13 368.59 377.36 386.47

17.00% 338.89 346.37 354.12 362.14 370.45 379.06 388.00 19.00% 341.28 348.65 356.27 364.15 372.32 380.78 389.55

21.00% 343.69 350.94 358.44 366.19 374.20 382.50 391.11

23.00% 346.13 353.26 360.63 368.24 376.10 384.24 392.67

25.00% 348.60 355.61 362.84 370.30 378.02 385.99 394.24 27.00% 351.09 357.97 365.07 372.39 379.95 387.75 395.83

Pre-Tax Cost of Debt

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krause fund research fall 2020 industrials northrop

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