Investors don’t often encounter “heads-I-win, tails-you-lose” scenarios, where they can get large gains from a stock even if the underlying firm has a major setback.  But that’s the scenario now in place for venerable defense contractor Northrop-Grumman Corp. (NYSE: NOC). The company may or may not win a key new contract. In either case, this is a stock to own. 

Northrop-Grumman, best known for the B-2 stealth bomber, is in a tight race for an estimated $90-billion contract to design and build a successor to the B-2. The Air Force wants a next-generation long-range bomber that incorporates the latest stealth technology, nuclear weapons capability and perhaps the ability to be flown without a pilot. A contract announcement should come any time now. 

For Northrop-Grumman, a contract win would lead to strong sales and profits for many years to come.   A contract loss may spell trouble — but that would, paradoxically, be a good thing for NOC shareholders.  

A Wide-Open Race 

Northrup-Grumman is bidding for the contract against rivals Lockheed Martin Corp. (NYSE: LMT) and Boeing Co. (NYSE: BA), which have teamed up to jointly pursue the award. The race is likely neck-and-neck, although analysts at Goldman Sachs think Northrop-Grumman has an edge thanks to its long, successful history with the B-2, and a design team renowned for aircraft innovation. 

Moreover, the firm often acts as a key supplier in other plane programs, even when it doesn’t act as the lead supplier. For instance, a portion of the fuselage for Lockheed Martin’s highly publicized F-35 Joint Strike Fighter is made at Northrop-Grumman’s Palmdale, California production plant. The firm also provides many of the smaller structural components and electronics for Lockheed and Boeing-made military aircraft, such as the F-35’s 360-degree field-of-view system designed for optimal visibility in combat. 

Lockheed and Boeing each offer specific expertise, such as the former’s state-of-the-art stealth technology and the latter’s knowledge of aircraft manufacturing. Together, the two firms also have a substantial scale advantage that could translate into superior price competitiveness. 

They certainly have the upper hand in sheer numbers of manned military aircraft produced. “Over the last 30 years, Boeing and/or Lockheed Martin have been prime contractors on about 95% of Air Force fighters and bombers,” Loren Thompson, CEO of the Arlington, Virginia based defense think tank Lexington Institute, recently told the Washington Business Journal. 

Northrop Grumman, he added, “only delivered nine military aircraft last year, compared to over 300 for the Boeing-Lockheed team.” 

Analysts say the bomber contract will add $9 billion to $10 billion a year to the victor’s top line, assuming no change in the Air Force’s current plan to order 100 of the new aircraft. That’s roughly a 40% gain from the $24 billion in annual revenue Northrop Grumman now generates. And the contract could actually provide a much larger revenue boost, since defense programs typically end up costing far more than originally estimated. 

What If Northrop Grumman Loses? 

Simply put, Northrop Grumman must win the new Air Force bomber contract to maintain a significant presence in the manned combat aircraft market. A loss would effectively end this presence, since the firm would no longer be making a frontline, piloted military plane. (The B-2 was its only one). The next chance to bid on a contract for such an aircraft won’t come along again for a generation. 

With nothing to replace the B-2, Northrop Grumman would be out a key revenue source and probably possess only modest growth potential. That could quickly relegate the firm to the role of perennial defense industry underperformer. 

Yet this outcome could prove profitable for shareholders, too, by increasing Northrop Grumman’s appeal as a breakup candidate. “Either company management or investors could well decide that the parts of the company were worth more than the whole, resulting in a series of unit sales,” the Teal Group’s aerospace industry analyst Richard Aboulafia recently told National Defense Magazine. 

For example, Boeing would be a likely buyer of Northrop Grumman’s aircraft unit, which has valuable contracts for unmanned military aircraft, helicopters and training aircraft. Among the many other Northrop Grumman assets that could attract interest from the rest of the defense industry are surveillance systems; navigation, control and targeting systems; cybersecurity solutions; and information technology services for the federal government. 

Risks To Consider: Because of federal government plans for large defense spending cuts in the coming decade, the Air Force may not be able to order as many of the new long-range stealth bombers as originally planned. Thus, the bomber contract may deliver substantially less revenue than expected.  

Action To Take: Northrop-Grumman is a compelling investment regardless of whether it’s selected to build the Air Force’s new bomber. If the company prevails, shareholders get the benefit of a large, sustained revenue injection that should supercharge an already solid lineup of defense products and services. If it loses the contract bid, the company stands to profit from numerous asset sales, or perhaps even an outright takeover.  

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