Defense contractor Northrop Grumman announced a major expansion of its ongoing share repurchase program yesterday, signaling that the company’s earnings per share (E.P.S.) are likely to increase for years to come despite softening demand from its federal customer. The company disclosed that its board had approved an increase in the funds available for share repurchases from $1 billion to $5 billion, enabling it to buy back 25% of its 235 million outstanding shares between now and the end of 2015. If that goal is fully met, the number of outstanding shares will decline from over 300 million when Wes Bush first became CEO in 2010 to about 176 million.
Share repurchases may be the most reliable way for military contractors to increase shareholder value during a period of declining Pentagon demand. Northrop Grumman generates 90% of its sales from the federal government, mainly in military programs. With defense spending constrained by deficit-reduction legislation, analysts estimate Northrop’s sales will decline from $25 billion in 2012 to $24 billion in 2013 and $23 billion in 2014. However, if the number of outstanding shares shrinks faster than sales — which appears to be management’s plan — the company can boost E.P.S. indefinitely. Investors see the potential, and have bid up the share price to $80, the highest it has been since 2008.
The unspoken assumption in this plan is that there will be no major cancellations in core product lines that unexpectedly reduce cashflow. However, that is probably a safe bet, since the company is well-positioned in stealthy strike aircraft, spy satellites, electronic warfare and other areas that the Pentagon has described as essential to future warfighting plans. Reuters aerospace correspondent Andrea Shalal-Esa raised the possibility in her report on the share repurchase that management might be positioning the company for a merger or sale. That move could make sense if the current defense downturn persists, but right now it appears the company has a formula for keeping shareholders happy no matter what happens.
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