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Northrop Struggles to Control Costs

Price for the latest ship has risen by $22 million. The builder will have to absorb 30% of overruns.

September 25, 2003|From Bloomberg News

Northrop Grumman Corp., the sole builder of U.S. nuclear aircraft carriers, is struggling to control costs on the military's latest ship almost two years after acquiring the business, according to Navy documents.

The price for the CVN 77, to be named for former President Bush, has risen $22 million to $3.17 billion, the documents show. That's after the Navy scrapped a $500-million weapons system and opted for 1960s-era technology to save money. The ship is about 30% complete.

Northrop must absorb 30% of the cost overruns, which would eat into the potential profit margin of 17%. The 2002 purchase of the Newport News shipyard, a 550-acre facility along Virginia's waterfront, made aircraft carriers Northrop's second-largest business. They accounted for 12% of Century City-based Northrop's $17 billion in total sales last year.

"One of the rationales of the acquisition was that they would take costs out," said Merrill Lynch analyst Byron Callan. "Whether Newport News is a better company being part of Northrop is still an open question."

The 30% overrun penalty is an important concern for Northrop investors because the carrier program provides the company some of its highest profit margins, said Nicholas Fothergill, an analyst at Banc of America Securities in London.

"Newport News is really a cash cow," Fothergill said. It allows Northrop "to generate $1 billion in cash a year, which they couldn't do before."

The average profit margin at Newport News, based in the Virginia city of the same name, is about 10%, Fothergill estimates. That compares with Northrop's margin of 8%.

Northrop's shares fell $1.96 to $86 on the New York Stock Exchange. They have fallen 32% in the last year.

The aircraft carrier Ronald Reagan, commissioned in July, was 28% over budget.

The Bush originally was projected to cost the same as the Reagan's final price tag of $3.14 billion, including the shipyard's profit, according to the Navy's Program Executive Office for Aircraft Carriers, which gave written responses to questions submitted by Bloomberg News.

The Navy and Northrop are renegotiating terms of the Bush contract related to the weapons system, said Navy spokesman Lt. David Luckett. He declined to elaborate.

If Northrop met its cost target of $2.69 billion and its scheduled 2008 delivery for the Bush, it stood to make a profit of $446.9 million, according to the Navy documents.

Northrop's performance in controlling costs on the Bush could help decide the fate of that program, said Patrick Garrett, a naval analyst at Global Security, a nonprofit organization in Virginia that studies defense policy.

"If things get delayed and run over budget on the Bush, they might run into some problems with the future carrier program," Garrett said.

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