Huntington Ingalls Industries

Second-quarter revenue grew 10.9% year on year to $3.4 billion, and segment operating margin jumped a whole point to 6.6%, yielding $224 million of profit. With the giant Navy contract for 14 nuclear subs finally in hand, management upped shipbuilding growth expectations to 6.6% and margin above 6%.

Why it matters: The covid pandemic had widespread impacts on industrial supply chains and staffing, which were felt quite keenly in HII's Newport News shipyard, where work underway on several US Navy submarines under contract terms that predated the pandemic became uneconomical. Ever since, HII and the Electric Boat Division of General Dynamics have been negotiating with the Navy to build future submarines using more-flexible staffing patterns, better pay for shipbuilders, and investments and incentives to increase the speed with which they finish the boats.

Key stats: Starting in the second quarter of 2025, HII logged a steady stream of Newport News revenue very close to $1.6 billion per quarter, reflecting work being completed at the shipyard at a higher, steadier pace than before. We expect shipbuilding margin, which disappointed investors by sinking to 5.2% in 2024, to reach 6.3% in 2026 and 8.1% by 2030, driven by a 9.7% margin at Ingalls and a 7.2% margin at Newport News.

The bottom line: We haven't materially altered our forecast, and we increased our fair value estimate for wide-moat HII to $382 per share from $379 mostly to reflect the time value of money. Investors bid HII's shares up more than 12% following the July 29 Navy contract announcement and July 30 earnings release, leaving about 18% upside to our revised fair value estimate.

Our $382 per-share fair value estimate implies an enterprise value to 2026 adjusted EBITDA multiple of 15.5 times and 21 times our earnings estimate.

We forecast revenue for each shipbuilding program in which HII participates. The Ingalls shipyard produces large, non-nuclear-powered warships such as amphibious warships and destroyers, while Newport News produces nuclear-powered ships, including aircraft carriers and submarines. Each shipyard has a stable and a growing product line: At Ingalls, we forecast revenue from amphibious warships will remain essentially flat over the next five years (albeit with some ups and downs as individual ships begin and end their construction and delivery to the Navy) and we expect revenue from Arleigh Burke destroyers to grow as much as 13% annualized over the next five years as Ingalls has won incrementally more awards to build these ships than its sister shipyard Bath Iron Works run by General Dynamics. At Newport News, we forecast revenue from building and refueling nuclear aircraft carriers will also remain essentially flat around $3.3 billion per year, but we see construction of Virginia- and Columbia-class submarines growing 7.1% annualized over the next five years. This renders our overall shipbuilding revenue forecast growing at 5.3% compounded through 2029.

We forecast HII's mission technologies segment, which produces uncrewed undersea vehicles and provides IT services to the government, to grow more or less with the company and will account for 25% of revenue, albeit at a slightly lower margin than its shipbuilding business.

After an influx of investment in its nuclear submarine facility over the next few years, we anticipate a gradual decline in capital reinvestment rates, as HII has completed a substantial capacity increase and can reduce capital expenditure to roughly maintenance levels. We’re normalizing our overall capital expenditure forecast as a percentage of sales at about 3%, well below recent surges above 5% in one shipyard or the other, and in line with the trailing 10-year average.

Our terminal segment operating margin forecast is 7.8%. This margin is roughly 2 percentage points higher than the company reported in the last three years, but not as ambitious as its historical peaks around 12% in 2016-8, largely due to overall cost growth and the lower margins in the company's acquired services business line. Our normalized tax rate for the firm is 21%, and our weighted average cost of capital is 7%, reflecting its negligible exposure to the macroeconomic cycle and moderate operating leverage.

We assign Huntington Ingalls a wide Morningstar Economic Moat Rating due to its intangible assets and customer switching costs.

We observe that wide moats are prevalent in the defense industry. We believe significant intangible assets imparted by extreme product complexity thwart new entrants and switching costs that a risk-averse customer faces emerge from the mission-critical nature of the products, often decades-long product lifecycles, and prohibitive time and cost to switch suppliers. These dynamics apply across HII's shipbuilding and mission technologies business lines. The firm routinely earns returns on invested capital in the low teens, half again as high as our 7.1% cost of capital estimate, and we forecast it to continue to do so for decades.

We believe incumbent firms are most eligible to service the military's need to purchase arms (broadly defined). Arms production requires specialized expertise and usually lacks commercial viability outside of defense (aside from commercial aerospace), so new entrants would need to develop know-how from the ground up. We observe only a few capable incumbents in each major category of defense systems development. SIPRI's arms industry ranking further evinces limited competition: Lockheed Martin, Boeing, BAE Systems, RTX, Northrop Grumman, Airbus, and General Dynamics have remained the top six or seven global arms producers for 15 years. HII, spun off from wide-moat Northrop Grumman in 2011, ranked 16th in 2024.

Naval product development lasts years to decades, and if the military is dissatisfied with a product, it's faster to work with the existing contractor to fix it than to fund an alternative. We view products with the longest procurement cycles, like aircraft carriers and submarines, as the moatiest, since they provide extraordinarily long-term revenue and profit visibility. We view short-cycle products such as defense IT contracting less favorably. Further, the military's ability to succeed while protecting soldiers' and civilians' lives is contingent on these products working as intended, which we think protects proven suppliers from competition.

We believe HII's shipbuilding business, at 75% of revenue and profits, enjoys one of the widest moats in the defense industry. The company presides over some unique and very rare assets with extraordinarily long useful lives and visibility into that use. For example, outfitting the nuclear reactor chamber of submarines is a rare capability even among defense contractors. To preserve this know-how at the only two facilities in the US that can, the Navy splits work on its subs (as well as conventional destroyers) between HII and General Dynamics. HII provides approximately half the contents of the Virginia-class submarine and 23% of the Columbia-class submarine. HII is the only producer of aircraft carriers, both 1,100-foot nuclear-powered and 844-foot turbine-powered amphibious assault carriers, for the US Navy and Marines. Add to these assets the intangibles gained from staffing and operating them, and the ship designs themselves. To award a wide moat, we look for durability of economic profits, not just their magnitude, and while HII returns only a few points above its cost of capital, we see those returns as unusually likely to persist beyond our 20-year moat horizon. An average naval warship operates for 35 years, with multiple shipyard visits for maintenance and refits, and HII has orders for carrier construction through the early 2030s with budget plans through 2048, augmented by refueling and overhaul contracts through the 2050s, and inactivation contracts through the 2070s.

We think the IT services business within mission technologies, about 17% of company revenue, has a narrow moat. It takes people with specialized technical skills, often combined with security clearances, to service these contracts, and we see intangible assets from implementing and integrating complex networked systems for government agencies. However, the rapid evolution of data processing, cybersecurity, and intelligence services, and their shorter contracting cycles, don't beget a wide moat. As evidence, several pure-play defense IT contractors exist, including Leidos, Booz Allen Hamilton, CACI, and SAIC, as well as segments of other prime contractors. Further, government IT contracts are recompeted periodically, which likely drives returns closer to cost of capital.

In 2024, the Navy's fiscal 2025 Battle Force Ship Assessment and Requirement report called for a crewed fleet of 390 ships by 2054, in large part due to geopolitical tensions. By 2044, the Navy plans to include 12 large carriers, 31 amphibious assault ships, 134 unmanned vehicles, 87 destroyers, 66 attack submarines, and 12 ballistic missile submarines. Because HII provides both nuclear carriers and amphibious assault carriers, nuclear submarines and destroyers, and builds the emerging category of autonomous unmanned vessels, we believe its moat is protected in the context of the Navy's evolving strategy: even if carrier force goals were reduced, we'd expect the freed-up budget to go toward more of HII's products.

A risk to HII's economic moat exists in the remote possibility of a significant lapse or error in its government contracting or production processes causing its exclusion from delivering key defense systems. More broadly, if a malfunction, breach, or vulnerability of one of the company's systems jeopardized military readiness, security, or capability, or caused casualties, it would represent a product governance failure and could breach the moat if it led to exclusion from a major program family or suspension from federal contracting. Apart from Ford class carriers, no single program represents more than 10% of our forecast returns, so we don't model it into our forecast.

The National Defense Strategy prioritizes modernizing the military to counter potential great power or near-peer adversaries. We think this will increase the proportion of the defense budget available to contractors.

HII is one of two major shipbuilders for the US Navy, which is a difficult-to-replicate business. The US has a vested interest in maintaining the financial viability of both shipbuilders.

Defense prime contractors operate in an acyclical business, and shipbuilders are particularly acyclical, which could offer investors some protection from an eventual US recession.

Design, production, and testing delays on large ship programs are common and can seriously dent HII's financials, especially from one quarter to the next.

HII used capital to acquire Alion, a defense-services company, which is outside its core shipbuilding competence.

Competing claims on future US budget spending may depress future defense spending or shipbuilding budgets in particular.