Navy shipbuilder Huntington Ingalls Industries [HII] on Thursday posted strong earnings in its first quarter driven by pension adjustments, but the company cautioned that its operating margins will be lower in the coming years as it brings on new work with the Navy that won’t be profitable initially.
HII for the past few years has been targeting 10 percent annual operating margin in its combined shipbuilding operations but the additional work in the channel that is part of the Navy’s planned expansion to 355 ships by the end of the next decade will put upfront pressure on margins, with the return on sales this year and next to fall to the 7 to 9 percent range, Mike Petters, HII’s president and CEO, said on the company’s earnings call. The long-term target remains in the 9 to 10 percent range, he said.
Despite the earnings pressure, Petters expressed his excitement to investors about the coming rampup in shipbuilding that is in sight. The company currently has 25 ships under contract and in the next few years could have another 20 to 30 ships to add to the construction mix, he said.
“I don’t have to tell you that this is the most exciting time I have seen in my 30-plus years in shipbuilding,” Petters said during his scripted remarks on the earnings call. “This new work supports our sales outlook for the next five years and forms the foundation that will support the business for the next 10 to 15 years.”
This week, HII submitted its proposals to the Navy for the block buy on the next two Gerald R. Ford-class aircraft carriers, CVN-80 and CVN-81. Petters said the development and rampup of the workforce at its two shipbuilding segments is going well but that his bigger concern is with the supply chain with regard to necessary investments and workforce needs ahead of the increase in naval ship construction.
“The fact that the government, that the Pentagon sent us a Request for Proposals on two carriers, it’s the biggest signal that the Navy could have sent to the entire supply chain that we are serious about this rampup in the size of the Navy and so let’s take that signal and run with it and let’s go invest in our facilities and invest in our workforce and get this done,” Petters said in response to an analyst’s question. He added that “we are seeing that excitement in our supply chain.”
Net income in the first quarter increased 31 percent to $156 million, $3.48 earnings per share (EPS), from $119 million ($2.56 EPS) a year ago, with the per share results 59 cents below consensus estimates. The company spent $20 million in one-time bonuses, which dented the bottom line, to employees in the quarter due to tax reform legislation that kicked in on Jan. 1. Operating margin increased 50 basis points to 10.2 percent.
At the operating level, profits were down at the Newport News Shipbuilding and Ingalls Shipbuilding segments on the bonus payments, a shift in sales favoring lower margin work, and lower risk retirement on the Coast Guard’s National Security Cutter program versus a year ago. The Technical Solutions segment swung to a $2 million profit, versus an $18 million loss a year ago when it recorded a charge related to a nuclear and environmental commercial contract.
Sales in the quarter increased nearly 9 percent to $1.9 billion from $1.7 billion on aircraft carriers and naval nuclear support services, amphibious assault ship programs, and oil and gas and fleet support services. All three segments posted higher sales.
Petters said his leadership team at Newport News is working to accelerate the launch of the Ford-class carrier John F. Kennedy (CVN-79) by three months to the fourth quarter of 2019. The ship is about 75 percent structurally complete and 43 percent complete overall, he said.
Orders in the quarter were $2.6 billion and total backlog stood at $22 billion, up from $21.4 billion at the end of 2017. Free cash flow was $47 million.