Northrop Grumman Corporation (NYSE:NOC), a leading global security company, is buying back an additional $4 billion of the company’s common stock, totaling the authorized share repurchase amount to about $5 billion, which is near 27% of the current market cap of $18.58 billion as of May 16, 2013. Northrop Grumman Corporation (NYSE:NOC) plans to retire about 25% of its shares outstanding by the end of 2015. The company will use its cash balance or free cash flow to fund the repurchase and issue debt if necessary. Earlier, Northrop Grumman Corporation (NYSE:NOC) had also increased its dividend by 11% to $0.61 per share. Northrop is working aggressively to create value for its shareholders.
By digging further and take a look at Northrop’s balance sheet and free cash flow, investors may want to pause before jumping in. First, as of March 31, 2013, Northrop Grumman Corporation (NYSE:NOC) had $3.18 billion total cash and $3.94 billion in total debt. Second, despite the earnings beat in the last quarter, the free cash flow was not pretty for Q1, as seen from the chart below. Lastly, by increasing its dividend, the company will likely need to borrow to fund the accelerated share repurchase. Northrop Grumman Corporation (NYSE:NOC)’s current debt/equity ratio of 0.4 is better than Lockheed Martin Corporation (NYSE:LMT)’s debt/equity ratio of 20.2 and the industry average of 0.7, but slightly higher than its close rival, General Dynamics Corporation (NYSE:GD)’ debt/equity ratio of 0.3.
Source: YCharts.com
Lockheed Martin Corporation (NYSE:LMT) is the No. 1 defense contractor in the US, whereas General Dynamics Corporation (NYSE:GD) offers a broad portfolio range from tanks, to IT, to weapons. While both companies and Northrop won’t be significantly impacted significantly for their profit due to sequestration, their sales already be negatively impacted by the budget cuts. Cost cutting is essential for these three companies to maintain profits, while the revenues are expected to be pressured further in the second half of the year, and even more so in 2014.
General Dynamics Corporation (NYSE:GD) is also facing the same situation as Northrop Grumman Corporation (NYSE:NOC). General Dynamics had increased its dividend by 10% to $0.56 per share in March and informed investors to expect more “shareholder-friendly” share buybacks in 2013. Taking a look at the chart below, General Dynamics Corporation (NYSE:GD)’ free cash flow does not look promising either with increasing dividend. That might be one of the reasons why Berkshire Hathaway Inc. (NYSE:BRK.A) sold its stakes in General Dynamics Corporation (NYSE:GD).
Source: YCharts.com
Although Lockheed Martin Corporation (NYSE:LMT) has a higher leveraged balance sheet, its free cash flow paints a better picture than the other two to support its increasing dividend. Lockheed Martin Corporation (NYSE:LMT)’s share repurchase activities had only picked up slightly since early 2012, as seen from the chart below.
Source: YCharts.com
Bottom line
While the share price had climbed double digits for all three companies YTD, investors need to be more careful with these so called “defense” providers now. With expected sales decline, increasing share repurchase and dividend further pressured the weak free cash flow for Northrop and General Dynamics Corporation (NYSE:GD). Investors need to stay alert, as share buyback may not always be a good thing for the long-term.
The article Should Investors Be Happy About An Additional $4 Billion Share Buyback? originally appeared on Fool.com is written by Nick Chiu.
Nick Chiu has no position in any stocks mentioned. The Motley Fool owns shares of General Dynamics, Lockheed Martin, and Northrop Grumman. Nick is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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