Citi: U.S. military shipbuilding backlogs surge as Citi sees strong revenue coverage at two companies

What changed in shipbuilding orders?

Following earnings releases, Citi observed a marked jump in shipbuilders’ backlogs, driven by unusually active contract awards. The bank said that although the trend had been trackable during the quarter, the magnitude of the backlog changes remained notable by historical standards.
Higher backlogs mean companies have more contracted work waiting to be performed, reinforcing Citi’s assessment of future revenue visibility in shipbuilding.

Before earnings, Citi noted that defense companies with shipbuilding operations led their peers in the degree to which their orders were funded. After earnings, the bank said funded orders at Huntington Ingalls Industries (HII) and General Dynamics (GD) still provided the highest coverage of future revenue among the companies it follows.
The comparison concerns the portion of orders that already has funding: compared with growth programs for which funding remains to be secured, it makes the two companies less dependent on future additional appropriations to support revenue associated with existing orders.
The U.S. midterm elections and the possibility of a major Democratic victory have prompted discussion about whether funding will materialize for defense growth areas. Citi believes the maritime sector, especially HII, continues to stand out in this context.

HII relies on U.S. government contracts for almost all its revenue. Budget fluctuations, program delays and changes in defense priorities could affect cash flow and growth; execution difficulties, employee retention and supply-chain issues could also affect program schedules and profit margins.
Approximately 70% of GD’s revenue is related to the U.S. government, and it likewise faces the risk of budget cuts or reallocations. Its business is also affected by demand for business jets, shortages of skilled workers and the supply chain.
Citi has a buy rating and a 379 dollar price target on HII, and a neutral rating and a 400 dollar price target on GD, reflecting its differing views on the two stocks despite their shared shipbuilding order advantages.