Why Huntington Ingalls Stock Sank in February

Shipbuilder Huntington Ingalls Industries (NYSE: HII) missed quarterly estimates and warned that there are no easy fixes to its execution issues. Investors abandoned ship, sending Huntington Ingalls' shares down 11% for the month of February, according to data provided by S&P Global Market Intelligence.

Long-term contracts weigh on results

Huntington Ingalls is perhaps the most important U.S. military shipbuilder, owner of the Newport News facility in Virginia that is responsible for the production of aircraft carriers and submarines as well as several shipyards spread across the Gulf Coast. There is steady and stable demand for the company's products, but the military can only buy so many ships at a time, and the ones under contract take years to complete.

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Huntington Ingalls earned $3.15 per share on revenue of $3 billion in the fourth quarter, missing Wall Street consensus estimates and reporting sales down 5.7% year over year. The company reported $74 million in negative profit adjustments in the quarter driven by labor and supply chain bottlenecks.

Part of the issue is that many of the ships under construction today were put under contract prior to the pandemic. Labor and raw material costs have skyrocketed in the years since, but efforts by Huntington Ingalls and other contractors to adjust these deals have so far fallen flat in Washington.

With some of these contracts not expected to be completed for years, there is no quick solution to what ails Huntington Ingalls. The company did announce plans to cut about $250 million in gross costs in 2025, but because some of its contracts are "cost plus" -- meaning they have to pass on some of those savings to the government -- the savings will be less than $250 million for Huntington assuming they're achieved.

Is Huntington Ingalls a buy?

In theory, Huntington Ingalls is a stable company with a significant moat. The Pentagon will be buying ships for years to come, and few companies on the planet have the ability to build the giant ships that make up a significant share of Huntington Ingalls' portfolio.

The company is profitable and generates free cash flow. It ended the year with a backlog of $48.7 billion. Given some of the concerns are related to the pandemic, it might be tempting for an investor to buy in now, collect the dividend currently yielding more than 3%, and wait out the storm.

But other dangers lurk on the horizon. Should the U.S. military increasingly favor smaller, uncrewed ships over the giant ships that are Huntington Ingalls' mainstays, there could be opportunities for newcomers to join the shipbuilding fight and break down some of the company's competitive advantage.

And even in the best of times, these massive ships are more of a one-off than a group purchase, making it hard for Huntington Ingalls to retain specialized workers who might only be needed sporadically as ships make their way down the assembly line.

Huntington Ingalls is unlikely to disappear, but there are better, more diversified defense stocks for investors to consider instead of this shipbuilder.

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Lou Whiteman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.