November 2019

Huntington Ingalls IndustriesNovember 3, 2019

Disclaimer

The analyses and conclusions of Queen’s Capital contained herein are based on publicly available information. The analyses provided

may include certain statements, estimates and projections prepared with respect to, among other things, the historical and anticipated

operating performance of the companies, access to capital markets and the values of assets and liabilities.

Such statements, estimates, and projections reflect various assumptions by Queen’s Capital concerning anticipated results that are

inherently subject to significant economic, competitive, and other uncertainties and contingencies and have been included solely for

illustrative purposes. Actual results may vary materially from the estimates and projected results contained herein.

Queen’s Capital assumes no responsibility or liability for any error, inaccuracy, or omission contained that may be made of such

information by the viewer. No information herein may be replicated without prior consent by the Executive Board of Queen’s Capital.

1

I.

II.

III.

IV.

VI.

VII.

VIII.

IX.

V.

Table of Contents

2

Executive Summary

Company Overview

Industry Overview

Investment Thesis I

Investment Thesis III

Catalysts & Risks

Valuation

Appendices

Pg 3

Pg 4

Pg 6

Pg 7

Pg 8

Pg 9

Pg 10

Pg 11

Pg 13

Investment Thesis II

3

Company

Description

Investment

Highlights

Valuation

Recommendation

• HII is America's largest military shipbuilding company, ranked #371 on Fortune 500

• 33 years of experience building non-nuclear, technologically advanced warships

• Enterprise value is $11.40bn USD and Market Capitalization is $9.33bn USD

• Key customers include the US Navy, Air Force, Department of Homeland Security

• Key competitors include General Dynamics, Austal, Boeing, and Caterpillar

Queen's Capital Recommends a Hold Currently, and a Buy at $225

Executive Overview

• Through scale, reputation, and relations with the US, HII holds a strong competitive

advantage in the industry attributable to management and brand

• HII has consistently delivered rates of return that outpace industry peers

• HII has grown FCF at consistent and strong rates over the years

• The company has been successful in managing debt levels for future flexibility

• The current share price for HII is $230.23 USD

• Comps relative to ship builders places shares of HII at a range of $216 to $223

• Defense manufacturers comps places shares of HII between $213 to $231

• Industrial manufacturers comps places shares of HII between $196 and $227

• Discounted cash flows analysis values shares between $180 and $253

• Price is somewhat inflated currently, as the stock rose ~4% from $222 last week

• At current prices, our target price of $250-255 leaves only 9-10% upside

• Based on qualitative and quantitative valuation measures, Queen's Capital

recommends a hold currently, and a buy at $225

4

Primary Markets and Customers

Company Description

Company Overview

Management Team

Sample Product Offerings

• Huntington Ingalls Industries is America’s largest

military shipbuilding company, formed on March

31, 2011, as a spin-off of Northrop Grumman

• With over 133 years of ship building experience,

Huntington Designs and builds non-nuclear,

technologically advanced, highly capable

warships for the surface Navy fleet, U.S. Coast

Guard and U.S. Marine Corps

• Ranked number 371 on the Fortune 500

Assault Ships

LHA 7

Tripoli

• 2ndAmericaClass amphibious assault ship

• 2013 start fabrication

• 2017 launch

• 2019 delivery

Dock Ships

LPD 30

• Awarded Detail Design & Construction contract in March 2019

• 2020 start fabrication

• 2023 launch

• 2024 delivery

Surface Combatants

DDG 119

• 69thArleigh Burke Class surface combatant

• 2016 start fabrication

• 2018 launch

• 2019 delivery

Shipbuilding

Navy Life-Cycle

Support, Training &

Fleet Services

Advanced Cyber &

Engineering

Army & Joint Forces

CBRNE Support

USPS, U.S. Court & Intel

Software SupportNavy & Air

Force Modeling & Simulation

Oil & Gas Services &

Engineering

Nuclear Operations

& Environmental Services

Unmanned Undersea &

Surface Ship Fleet Support

Mike Petters(CEO)

Brian Cuccias(VP, Ingalls

Shipbuilding)

Andy Green(VP Tech Solution)

Jennifer Boykin(VP, Newport News

Shipbuilding)

5

Price-Volume Analysis

Company Overview

Capitalization Table

0.0

0.6

1.2

1.8

2.4

3.0

$150.00

$172.00

$194.00

$216.00

$238.00

$260.00

25-Oct-18 25-Feb-19 25-Jun-19 25-Oct-19

1-Aug-19: 2nd

Quarter EPS

Misses Lowest

Estimates

1-May-19: Market

Overreaction to

Media Concerns,

Post Revenues

Above Highest

Estimate

11-Nov-18: 3rd

Quarter Revenues

Beat Highest

Capitalization

Share Price (31-Oct-2019) (C$) $225.66

Basic Shares Outstanding (mm) 41.3

Market Capitalization (C$ mm) 9,327.6

(-) Cash & Equivalents (C$ mm) (29)

(+) Total Debt (C$ mm) 2,099

(+) Minority Interest (C$ mm) -

Enterprise Value (C$ mm) 11,398

Trading Multiples

EV / LTM EBITDA 13.2x

EV / 2019E EBITDA 11.8x

EV / 2020E EBITDA 9.4x

P / LTM E 17.7x

P / 2019 E 16.2x

P / 2020 E 13.9x

Market Data

52-Week High (C$) $242.05

52-Week Low (C$) $173.80

Levered Beta 1.24

6

Industrials (Aerospace and Defense)

Industry Overview

Key Competitors

Overview Recent Trends

• Industry revenue was US$929bn in 2018

- 51% was end use manufacturers, 49% was supply

chain

• This industry employs ~2.5mm people and has been

around that number since 2010

• Business activity generates roughly 3% of the U.S. total

Federal tax revenue and 1% of total U.S. state and local

tax revenue

• Governments annual budget dictates industry

performance

- Defense spending went up ~12% this year from last

(US$695.1bn)

• Growing aircraft demand, backlog remains strong

• Geopolitical risks increase worldwide

- Military spending is going up

• Duties placed on steel and aluminum have impacted

companies in this industry

- Higher costs on trading

• Significant M&A activity over past couple of years

- This will remain constant with the pressure to reduce

costs and increase production rates

• A&D industry growth is led globally by the U.S.

Industrial Equipment

ManufacturersShip Builders

A&D

Manufacturers

7

High Barriers to Entry

Wide Economic Moat

Investment Thesis #1

Strong Management Team

Superior, Trusted Military Brand

Scale & Competitive Advantage

• HII is the only builder of US Navy Aircraft Carriers, the World’s largest warships, and one of only two builders

of nuclear-powered submarines

• Largest US Navy supplier by a substantial margin, HII has built more than 70% of the Navy’s Warship fleet.

• Supplies cost the company billions of dollars each year, and a trusted brand provides flexibility with suppliers

which is key to profitability in the industry – this is a specific advantage over smaller ship builders that

compete for contracts

Positioning

• Recently honored by the “Seabee Memorial Scholarship Association”

• “American brand” - suppliers in 49 states, top 10 “Best for Vets” employer, and high national security focus

• HII currently has a $39.4bn backlog for orders,

which is approximately 3 years' worth of

revenue.

• US Forces are very particular with suppliers,

emphasizing strong and consistent relationships,

this makes it very difficult for new entrants to

steal market share from HII

• Scale of resources and technological capabilities

to compete in this industry are massive.

• Current products and high R&D put HII in a very

strong position to be awarded future contracts

• Experienced team with a focus on longevity.

• Capital program aimed at developing shipyards

for future products adds to HII’s ability to secure

future contracts

• ”Path to 2020” plan aimed to address

sustainability issues was very successful,

proving management’s ability to invest in the

future while maintaining high short-term profit

levels

8

Superior Rates of Return

Investment Thesis #2

Data Source: Capital IQ

High Efficiency

Return Ratios Relative to Peers High Efficiency

HII is clearly far more efficient than its peers with respect to costs and returning cash on all assets, capital

invested, and equity

• This higher rate of return is a key reason why HII will be able to outperform its peers in attracting greater

investment over the long term

• Effectively, superior rates of return will allow HII to compound at a faster rate than peers now and in the

future, as well as provide flexibility in capital investments given high returns

• In an industry driven by relations and ability to secure government contracts, these high returns and margins

will allow HII to secure contracts down the road given their ability to offer competitive prices

• HII LTM Ratios: 41.3% ROA, 16.5% ROIC, 7.9% ROE

• Peer LTM Ratios (Median): 25.9% ROA, 10.9% ROIC, 6.2% ROE

9

Superior Capital Allocation and Conservative Balance Sheet

Investment Thesis #3

Historical CapEx vs. Normalized CapEx (% of sales)

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

0

50

100

150

200

250

300

350

400

450

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

CapEx Capex (% of Sales) Linear (Capex (% of Sales))

Normalized CapEx = 3.6% (% of sales)

• FCF recently reduced due to significant

investment in CapEx for new Generational

Shipyard amounting $1.8B - $1.9B for FY’16-20

• Stable cash flow generation of ~$500M

• Consistent growth in dividends at minimum 10%

annual increase and opportunistic $2.2B share

buyback since FY’16

• Acquisitions in the Technological Segments

increasing segment revenue at CAGR = 15%

• Almost no short-term debt and $1.7B LT debt,

due at least 2024 with low, fixed weighted

average interest rate of 4.2%

• Debt/Equity = 1.1x

• Debt/EBITDA = 1.92x

• Interest coverage ratio of 13x provides a cushion

in recessionary environment

Historical CapEx vs. Normalized CapEx (% of sales)

Strong FCF Growth Potential and Share

Repurchase Program Conservative Levels of Debt

10

Federal Reliance

Catalysts & Risks

Catalysts Risks

US Political Environment

• The election of Donald Trump has been positive for HII

(11.4% share price spike after 2016 election)

• BCA act of 2011 would have limited defense spend –

Trump's government enacted BBA

• Increased DoD spending of 24.6% since election

• If Trump is reelected in 2020, government will likely

continue to be favorable for HII

Global Instability

• Long lead times generally prevent drastic short-term

changes, but increased global tensions will further

America’s appetite for weaponry in the long-term

• Geopolitical risk index has been trending upwards since

2010, signaling a greater need for military force

• HII well-positioned to meet demand, and already seeing

the increase in revenues from a risk-averse US

Diversification of Business

• Over the past three years, HII has acquired G2, Fulcrum,

and Camber for $77m, $195m, and $369m respectively

• All companies represent a foray into the military

technology sphere, allowing HII to move away from the

confines of the ship-building sphere

• Camber has already contributed ~$300 million per year to

revenue

• May be impactful in the long-term as warfare becomes

more digital and defense solutions are required

Loss of Government Revenue

• The US government accounted for ~97% of HII revenues

in 2018 – loss would be devastating

• Can terminate contracts at any time with little notice

• Mitigation: Seems unlikely that DoD/Navy spend is

decreasing – see graph below

Election of Less Supportive Officials

• Democratic candidates generally against growth of

military spending (except for Biden)

• Warren, the second-place Democrat, is particularly

against defense contractors (for “ending the stranglehold”)

• Stock dropped 10.5% after 2012 reelection of Obama

• Mitigation: Attempts to reign in US military spending

have historically been short-term at best; furthermore,

Biden (the current Democrat favorite), will grow military

spend

(15%)

(10%)

(5%)

0%

5%

10%

15%

20%

$ -

$200bn

$400bn

$600bn

$800bn

$1,000bn

2013 2014 2015 2016 2017 2018 2019 2020E

US Gov't Defense Expenditure

DoD Expenditure % Change in Navy Expenditure

11

Football Field Graph

Valuation

12

16.2x

30.1x

16.0x 14.8x 14.0x 13.7x 13.5x10.6x

nmf

21.4x19.1x

15.8x 15.4x12.7x

8.6x

4.2x

19.0x16.0x

13.5x

P/E 2020

Key Multiples – P / E

16.0x

37.6x

20.2x15.3x

14.6x12.6x

11.2x 10.7x

nmf

23.1x 21.4x17.4x

12.4x9.4x

n.a. n.a.

20.0x19.6x

14.5x

P/E 2019

- Low P/E ratio compared to peer universe suggests undervaluation

- Predicted increase in P/E compared to peers demonstrates expected growth

Median: 19.6x

Median: 16.0x

13

14.4x

22.1x

16.5x

11.8x10.8x 10.4x

8.3x

nmf nmf

17.8x15.5x

14.2x12.4x

10.9x8.5x

1.6x

13.1x 13.1x12.0x

EV/EBIT 2020

14.4x

24.4x

16.3x

12.4x10.0x

8.3x 8.2x

nmf nmf

20.4x

16.9x15.6x 14.8x

11.3x9.7x

nmf

15.3x14.0x

12.6x

EV/EBIT 2019

Key Multiples – EV / EBIT

- EV/EBIT more relevant than EBITDA due to the capex intensive business model

- Trading at a slight premium compared to median

Median: 14.0x

Median: 13.1x

14

1.3x

6.3x

2.5x

1.6x 1.3x 1.1x 1.1x0.8x 0.7x

2.5x

1.7x 1.7x 1.6x

0.9x 0.8x

0.1x

1.6x1.2x

0.7x

EV/Sales 2020

1.3x

6.7x

2.5x

1.5x 1.4x1.4x

0.9x 0.8x 0.7x

2.7x 2.5x1.9x 1.7x

1.0x 0.8x0.1x

1.6x1.3x

0.7x

EV/Sales 2019

Key Multiples – EV / Sales

Median: 1.3x

- Trading at median for 2019, though undervalued compared to equipment and aerospace manufacturers

Median: 1.2x

15

Ian Morrison Max Madon Julia Li Matt Halpen

Portfolio Manager

Queen's Capital

Portfolio Manager

Queen's Capital

Analyst

Queen's Capital

Thank you

Angad Paul

Analyst

Queen's Capital

Taras Wylynko

Analyst

Queen's Capital

Portfolio Manager

Queen's Capital

16

Public Market Comparable Analysis

Appendix I

17

Discounted Cash Flows Analysis

Appendix II