Krause Fund Research Fall 2018

Analysts:

Huntington Ingalls Industries, Inc. (HII) Industrials – Aerospace & Defense

Emmett Corrigan Benjamin Wojtynek emmett-corrigan@uiowa.edu benjamin-wojtynek@uiowa.edu

November 9, 2018

Stock Rating: HOLD

Target Price: $245 - $255

Investment Thesis

DCF Model $233.64 DDM Model $254.09 Relative Multiple $281.52 Price Data Current Price $223.65 52wk Range $207.33 - $270.88

Key Statistics Market Capitalization $9.2 B Shares Outstanding 42.95 M Institutional Ownership 87.19% Five Year Beta 1.22 Dividend Yield 1.35% Payout Ratio 19.47% Est. 5 yr Growth 1.95% Price/Earnings 17.64 Price/Earnings (FY1) 15.51

Profitability Operating Margin 21.88% Profit Margin 6.44% Return on Assets 9.01% Return on Equity 28.98%

We recommend a HOLD rating for Huntington Ingalls Industries, Inc. With the prospect of sequestration in 2020 and a gridlocked Congress, the defense industry spending spree is likely coming to a halt.

Drivers of Thesis

• The Bipartisan Budget Act of 2018 is set to expire at the end of 2019 and there has not been any talks of suspending sequestration at the start of 2020.

• 96% of HII’s revenues are derived from the US Government and its agencies; a decrease in discretionary defense spending will significantly harm their topline

• We anticipate a strong finish to 2018 and a strong 2019 powered by completion of current contracts and refilling the backlog with new contract awards

Risks to Thesis

• The US Government may shut down if no budget agreement is met before the start of FY 2020

• General Dynamics begins to design and construct non-nuclear powered ships in addition to the nuclear powered submarines they already produce

• Congress reaches an agreement to continue to increase defense spending at all-time rates

12 Month Performance Relative Financial Performance

Company Description

Huntington Ingalls Industries, Inc. (NYSE: HII) is America’s largest military shipbuilding company and a provider of professional services to partners in government and industry. HII operates in three segments: Ingalls Shipbuilding, Newport News, and Technical Solutions.

Earnings Estimates

Year 2016 2017 2018E 2019E 2020E 2021E EPS 12.24 10.41 15.51 17.45 19.20 20.88 Growth 45.20% -14.38% 48.03% 12.49% 10.00% 8.80%

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Our team recommends a HOLD rating for Huntington Ingalls Industries, Inc. (NYSE: HII) for the University of Iowa Krause Fund. We expect HII to have continued revenue growth at the close of 2018 and through 2019, but there is a great deal of uncertainty surrounding the defense spending budget after the expiration of the Bipartisan Budget Act of 2018. With a gridlocked Congress, we do not anticipate an increase in defense spending if a budget agreement is reached.

Our forecasts and given models support our HOLD rating. Our current price target is $245 - $255.

Real Gross Domestic Product (GDP)

United States’ Real GDP in 2018 had one of the strongest performances in recent years. After an annualized growth rate of 2.2 percent in Q1, real GDP increased by 4.2 percent in Q2, followed by another 3.5 percent increase to a total of $18,671.497 billion in Q3. (Source: FRED13)

(Source: Bureau of Economic Analysts14)

Real GDP is an important factor for determining economic outlook, especially for the Industrials sector as it is strongly correlated with real GDP. Increases in real GDP shows the economy is performing well and creates consumer confidence. This is a positive sign for the Aerospace and Defense industry as much of its revenues are generated from businesses and government entities that want to expand and purchase new machinery or equipment as they expect the economy to grow.

With encouraging increases in GDP during 2018, we believe the economy will continue to grow but at slower growth rates. We believe real GDP growth through the end of 2018 will be approximately 3.0 percent. Then, through 2020, we estimated growth to slow even more and level out to around 2 percent.

Interest Rates

Interest rates are an important economic factor, especially in the Industrial sector as companies require large amounts of capital to fund their operations. Firms borrow capital at the given interest rates and use the rate as their cost of debt. The amount of capital companies borrow depends on the interest rates. Companies will borrow more capital when rates are low since their cost of debt will be low and will avoid borrowing when high.

The current U.S. 10-Year Treasury Bill is at 3.184 percent, as opposed to last year’s rate of 2.405 percent. Shown in the graph below, the current interest rate is relatively low compared to historic rates. The low rates encourage companies to borrow and invest in capital projects. However, due to the high performing economy and the threat of high inflation, the U.S. Federal Reserve has been raising interest rates to keep up with inflation. So far this year, the Federal Reserve has raised interest rates three times and plans on raising rates once more before the year end. In addition, they officials have projected three interest rate increases in 201916.

(Source: CNBC 16,17)

Increasing interest rates indicate that the overall economy is healthy. However, higher interest rates would negatively affect companies with a need to raise capital by deterring them away from borrowing, slowing down economic growth.

Commodities

Commodities play a major role in all sub-industries within the Industrials sector as their costs are sensitive to the volatility of commodity prices. Commodities prices are mainly driven by supply and demand factors that could be disrupted by a wide variety of events such as inclement weather, political tensions, or economic events. Two commodities that have the largest impact on the Aerospace and Defense industry are crude oil and metals.

Economic Outlook

Executive Summary

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Crude Oil

Crude oil is a highly demanded commodity around the world and has been at the center of many global political events. Crude oil prices are highly volatile and are determined by supply and demand factors, the oil futures market, and the production management of the Organization of Petroleum Exporting Countries (OPEC). In 2018, WTI crude oil prices saw an increase of 25 percent through September followed by entering a bear market and sharply declining to $60.19 a barrel (November 9, 2018) (Source: Trading Economics18)

The Industrials sector’s performance is reliant upon crude oil prices and the chart below shows its sensitivity to the changes in crude oil prices. In this chart, the returns of the industrial sector’s ETF (XLI) are correlated to the returns of WTI crude oil. As oil prices increase, demand for products within the industrials sector typically increase, creating positive returns.

(Source: Bloomberg24, 25)

Due to correlation with unpredictable crude oil prices, it is difficult for companies within Industrials to confidently forecast production. Future crude oil prices will be difficult to predict due to the trade war between the U.S. and China, the two largest consumers of oil, which will likely keep OPEC to foster lower energy prices. However, 82 percent of traders, according to the IG Client Sentiment Report, continue to be net-long on crude oil, which shows high confidence in oil prices. (Source: Daily FX 21)

Base Metals

Base metals are commonly used in industrial and commercial applications for inputs in areas such as construction and manufacturing. Base metals include aluminum, steel, copper, lead, nickel, tin, and zinc and are much less expensive than precious metals, such as gold, silver, and platinum. Base metals have a higher supply than precious metals, making them inexpensive and heavily relied upon by Industrial and Manufacturing companies.

Base metals could also be used as economic indicators. For example, economists use the Manufacturing Purchasing Managers’ Index (PMI) to gauge the economic health of the manufacturing industry. We can use the Manufacturing PMI and compare it to the Base Metals Spot Price Index, such as in the chart below. Since base metals are so widely used amongst industrial companies, the demand for the metals can indicate production levels. Low demand for base metals result in price drops and can create fear in the marketplace. By comparing the spot price index of base metals to the Manufacturing PMI, we see evidence that the economic health of the Manufacturing industry is directly impacted by changes in the price of metals.

(Source: Bloomberg 24, 25)

Capital Markets Outlook

The U.S. capital markets have been strong these past few quarters, boosted by GDP growth, high corporate earnings as a result from increased consumer spending from tax cut benefits, and low unemployment. However, we believe the stock market has reached its peak growth through 2020. There have been a few stock market corrections driven by losses from technology companies, domestic political tension, and trade wars with China. In addition, the Federal Reserve plans on continuing to increase interest rates and slow the economy, which is an area of concern for many companies in need of borrowing capital.

Despite these number of concerns, we still believe there will be sustained GDP growth through 2020. We forecast a moderately-slow growing equity market resulting in decreased GDP growth and an overall tightening in fiscal policy. (Source: Trading Economics18)

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Industry Outlook

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Overview

Huntington Ingalls Industries, Inc. operates within the Aerospace & Defense space of the Industrials sector. The industry is split into two main markets: Aerospace and Defense. First, the Aerospace sector is mainly comprised of companies that produce, sell and service commercial aircrafts. Aerospace revenues are primarily derived from fulfilling commercial aircraft orders. The Defense sector is then made up of companies that produce military weapons, equipment, and systems. Defense companies’ performance and revenue is primarily driven by contracts with governmental agencies. These two sub-sectors are classified as one industry under the S&P 500 as a majority of the companies in the industry operate in both sub-sectors. The S&P 500 Aerospace & Defense industry is made up of 13 companies with total market cap of $697 billion (Bloomberg25). Revenues in this industry are highly correlated with GDP growth, the US Defense budget, and other leading economic indicators that contribute to cyclical nature of the sector. The US Defense Budget, however, is less correlated with the overall economy than GDP growth and other economic indicators. Huntington Ingalls is primarily a defense contractor for the US Government so their performance has a higher correlation to the defense budget. Because most companies in the industry have larger revenue mix between government and commercial customers, it can be difficult to find a pure comparison.

Industry Trends

The Aerospace & Defense industry is in the mature life cycle phase. This means that growth of the companies generally follows economic growth. The economy has been in a period of significant economic growth for the last 9 years so the industry has seen major growth in that period.

(Source: Yahoo! Finance)

The above chart illustrates the performance of the iShares US Aerospace & Defense ETF versus the S&P 500 thus far in 2018. The outperformance can be attributed to strong GDP growth and robust government spending

under President Trump. The industry was hit hard by the market-wide selloff throughout the month of October, but has rebounded on the back of positive earnings and the prevailing sentiment that increased defense spending in 2019 is going to positively affect the industry.

US Defense Spending

The US already has the highest defense spending of any country and President Trump’s administration plans to increase spending dramatically. In August 2018, Trump signed the National Defense Authorization Act bringing the total US defense budget to $686 billion in 2019. This represents an increase of 12 percent from 2018’s defense budget (Department of Defense).

(Source: Department of Defense 1)

The above chart compares the differences between the budgets for 2018 and 2019. There are significant increases all areas of the budget with the exception of Revolving and Management Funds. The approved budget calls for an additional 25,900 military personnel. The 37 percent increase in the Military Construction Bill provides a very positive outlook for the Aerospace & Defense industry in 2019 as companies look to fill their construction pipeline.

In 2011, President Obama signed the Budget Control Act (BCA) that required a “Super Committee” within Congress to reduce the budget deficit by $1.5 trillion over the next decade. The BCA called for sequestration—automatic spending cuts—if the Super Committee failed to reach an agreement prior to the start of Fiscal Year 2013. The committee failed to reach an agreement and sequestration has been in effect since 2013 and is set to expire at the end of 2021. President Trump, though, signed into law the Bipartisan Budget Act of 2018. This act amended the BCA by increasing discretionary defense spending by $80 billion and $85 billion for fiscal years 2018 and 2019, respectively (Congressional Research Service5). This created a stable and predictable defense spending environment for companies in the industry to

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plan around. There is yet to be a new Bipartisan Budget Act that would increase spending limits for 2020 and 2021 (National Law Review3). If there is no new deal, sequestration will go into effect. Sequestration would significantly hinder the growth that the Huntington Ingalls and the Aerospace & Defense industry is currently experiencing.

There is great deal of uncertainty for the industry following the expiration of the Bipartisan Budget Act of 2018 with Congress being in gridlock. Our team expects a new Bipartisan Budget Act to be in place by the start of fiscal year 2020, but with a relatively smaller size of discretionary defense allocations.

Contract Awards and Backlog

The Department of Defense and other governmental agencies award defense companies with contracts for future business. Contracts are awarded following a bidding process between companies that are seeking the new business. It is important for defense contractors to consistently win new contracts because these contracts ensure that they will have a full pipeline of work in the coming years.

Companies are often awarded contracts before they have the production capacity to fulfill the contracts. These contracts that they cannot currently work on contribute to their backlog. A company’s backlog is a metric that represents possible future revenues.

(Source: HII Annual Report 6, GD Annual Report 8, LMT10 Annual Report, NOC Annual Report11, RTN Annual Report12)

The above graph illustrates the sales backlog ratio for each of the last four quarters Huntington Ingalls and a few of its peers. A strong sales backlog ratio is relatively constant as it implies that the company is constantly

renewing its backlog as it completes current work. Huntington Ingalls’ backlog is in a strong position as it is matching its sales growth with backlog growth. Our team expects this trend to continue into 2019.

Porter’s Five Forces Analysis

Competition: High

Huntington Ingalls’ generates 96 percent of its revenues from the US Navy, the US Coast Guard, and other government agencies. They primarily compete with General Dynamics (NYSE: GD) for all shipbuilding and submarine contracts. Huntington Ingalls has established themselves as a reliable shipbuilder for the US Government. In order to maintain and increase their market share, it is important that they continue to be on-time with ship deliveries and work to be the most cost efficient option for the DoD, US Navy, and US Coast Guard.

(Source: HII Annual Report6, GD Annual Report7)

The high concentration of revenue from the US Government poses a significant threat to Huntington Ingalls’ business if they were to begin to lose market share and the defense budget decreased. The addition of their Technical Solutions business in December 2016 is helping them to diversify their business mix. Our team expects Huntington Ingalls to maintain their competitive position within the industry.

Threat of New Entrants: Low

Huntington Ingalls is one of two Navy shipbuilders for the US Government, with the other being General Dynamics. Additionally, the Aerospace & Defense industry is highly regulated by the US Government so it is very difficult for new companies to break into the market. Given these two characteristics, the threat of new entrants is very low. The US Government awards contracts to trusted and proven contractors because of how heavily scrutinized each allocation of defense budget dollars. Additionally, the

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capital requirements for a new company to enter into the space are very steep.

Power of Suppliers: Low-Moderate

The most significant material that Huntington Ingalls currently purchases in order to meet production demands is steel. Other supplies in which they purchase in large quantities and are required for production are paint, aluminum, pipe, electrical cable, and fittings. Huntington Ingalls must obtain certain supplies from suppliers that are approved by the US Government. Long-term contracts with these approved suppliers minimizes their risk to increase the prices of supplies. Any supplier contract that is subject to commodity price volatility potentially increases the power of suppliers.

Power of Customers: High

Given that the US Government and its agencies have the authority to award defense contracts to companies, the power of customers in the industry is very high. For every contract that is to be awarded within the industry, the companies must put together a detailed bid related to pricing and timeline of completion. The US Government and its agencies then select the company to award the contract to after reviewing all bids. The customer controls the entire process in the Aerospace and Defense industry. Huntington Ingalls is, however, in a very strong position as one of only two Navy shipbuilders. The government still has significant control over the pricing of the contract, but Huntington Ingalls remains in a strong position to be continually awarded contracts.

Threat of Substitutes: Low

Currently, there is no real substitute to the products that populate the Aerospace & Defense industry. Most firms in the industry have highly specialized products that are experiencing economies of scale. The extremely high capital requirements for a new and alternative make it very difficult for new firm to potentially compete.

Competitive Environment

Huntington Ingalls operates almost exclusively as a military shipbuilder within the defense space. The only other major shipbuilder in the space is General Dynamics. All other defense contractors operate in different product areas such as weapon development, military aircraft development, and military information systems. Additionally, almost all other defense contractors have a presence outside of the US.

General Dynamics Corporation (NYSE: GD): GD operates through four business groups: aerospace; combat

systems; information systems and technology; and marine systems. Its marine systems group designs and builds nuclear-powered submarines, surface combatants, and auxiliary and combat-logistics ships for the US Navy and Jones Act ships for commercial customers. Additionally, they are a provider of repair services for several US Navy ship classes. GD currently has a market capitalization of $53.6 billion. Revenues have only grown at .03 percent CAGR over the past 5 years. Huntington Ingalls and GD routinely partner on the Virginia-class submarine program with one company acting as the main contractor and the other the subcontractor

Financial Ratio Comparison

When comparing GD and Huntington Ingalls, we found that it was important to look into key financial ratios to assess the overall health of both companies. We also looked at industry specific metrics to show what major drivers help them gain a competitive advantage over each other.

EV/EBITDA

(Source: FactSet)

Comparing the two companies’ EV/EBITDA multiples with the industry average allows our team to evaluate them independent of financing sources and overall size differences. Given that both Huntington Ingalls and GD have a lower multiple than the industry average, they may both be undervalued and have room for growth.

Gross Margin

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(Source: HII Annual and Quarterly Reports6,7; GD Annual and Quarterly Reports8, 9)

Evaluating gross margin trends between competitors is important because it reveals which company has the advantage when it comes to controlling costs. Huntington Ingalls experienced a decreasing margin from 2016 to 2017, but has seen increased margins so far in 2018 largely due to the timing of delivery of a couple of ships. The opposite is true for General Dynamics as they have seen their margin slightly erode in 2018. This can be attributed to their recent acquisition of CSRA as they have not fully synergized.

Revenue/Employee

(Source: FactSet, HII Annual and Quarterly Reports6, 7; GD Annual and Quarterly Reports8, 9)

Evaluating total revenue per employee provides a look into how efficiently each employee is being used. Both companies are on pace in 2018 to exceed their total revenue per employee multiple. General Dynamics has a clear advantage in terms of maximizing employee usage. This can be attributed to the fact that General Dynamics derives 29 percent of revenues from their Information Systems and Technology segment which requires significantly less employees than the number of employees needed in a shipyard. Our team expects both

companies to continue to improve their employee usage rates as they become more efficient.

Company Overview

Huntington Ingalls is America’s largest military shipbuilding company and a provider of professional services to partners in government and the industry. Huntington Ingalls can be broken down into three main segments: Ingalls Shipbuilding, Newport News, and Technical Solutions. The Newport News segment was the main source of income in 2017, accounting for 55 percent of revenues. The Ingalls Shipbuilding segment accounted for 32 percent of revenue and Technical Solutions accounted for the remaining percentage. The US Government, specifically the Department of Defense, was responsible for 96 percent of Huntington Ingalls’ revenue which poses a significant risk if the US Defense Budget were to be cut. Huntington Ingalls employs approximately 38,000 people and only operates in the US. Huntington Ingalls’ customers consist of the US Navy, the US Coast Guard, commercial customers, and other government agencies. Huntington Ingalls share price is down about 2 percent on the year as a result of the recent market selloff.

Financial Summary

Huntington Ingalls has performed very well so far this year, but its stock price is down about 2 percent year to date. The negative stock return is largely due to a market selloff in October that eliminated most of the year’s gains. Huntington Ingalls recently reported strong third quarter earnings. They reported revenues for the quarter of $2.1 billion, up 11.8 percent from the third quarter in 2017. They had an operating margin of 13.9 percent, up 1 percent from the year before. They reported diluted EPS of $5.29, beating the consensus estimates by $1.16. Huntington Ingalls’ cash balance was reduced to $68 million at the end of the third quarter primarily due to $512 million in share repurchases and $434 million in contributions to pension and postretirement benefit plans. Huntington Ingalls’ backlog is currently $21.9 billion, of which $16.65 billion is already funded. With defense spending at an all-time high, we predict 2018 EPS to come in at $15.45 - $15.55/share.

Corporate Strategy

Huntington Ingalls is more than half way through their “Path to 2020” plan that outlines a $1.5 billion commitment to capital investments at their two main shipyards, Ingalls and Newport News. The investments

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Company Analysis

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have been focused on improving affordability and efficiency across shipyards.

In the short term, they are focused on executing existing contract work and capturing quality new contracts before the Bipartisan Budget Act expires at the end of 2019. Huntington Ingalls will continue to compete with General Dynamics for new shipbuilding contracts for the foreseeable future. They are also focused on expanding their Department of Energy portfolio within the Technical Solutions segment.

From a cash deployment perspective, they are primarily focused on returning substantially all of free cash flow to shareholders as part of $2.2 billion share repurchase and dividend program that extends into 2022. They have made $512 million in repurchases thus far in 2018, reducing the total shares outstanding by 4.76 percent.

Products and Markets

Huntington Ingalls’ three segments can be further broken down into major programs within those segments. Below is the revenue decomposition of these major programs thus far in 2018.

(Source: HII 2018 Q3 Report7)

Huntington Ingalls denotes an “Intersegment Eliminations” line item within their revenue decomposition to signal an overlap of revenue recognized between two segments. We expect to see a similar mix of revenues as we move towards the end of 2018 and into 2019. We expect a slower rate of overall revenue growth moving into 2020 and beyond due to uncertainty surrounding the defense budget with a gridlocked Congress. We believe that Technical Solutions could then contribute a greater percentage to total revenues.

Ingalls Shipbuilding

Ingalls Shipbuilding produces non-nuclear ships such as amphibious assault ships, surface combatants and

national security cutters. Ingalls year to date revenues are up 7.1 percent to $1.91 billion through the end of the third quarter in 2018. Additionally, Ingalls has accounted for 31.92 percent of all revenues for the same time period. Ingalls was awarded a $5.1 billion multiyear contract for six surface combatant destroyers. Additionally, they were awarded a $165.5 million advance procurement contract for amphibious assault ships. We believe that these contract awards will help sustain and grow revenues into the start of 2020, but believe that growth will slow as the uncertainty surrounding the defense spending budget looms.

Newport News

Newport News’ core products are nuclear-powered ships such as aircraft carriers and submarines. They are one of only two shipyards (General Dynamics being the other) capable of designing and building nuclear-powered submarines. They are also the only shipyard that provide inactivation services for nuclear-powered aircraft carriers once the service life of a carrier is complete. Newport News year to date revenues are 13.9 percent to $3.44 billion compared this same time last year. Newport News currently has backlog of $11.2 billion, of which $7.5 billion is funded. Similar to Ingalls, we anticipate that the current backlog will provide revenue growth into the start of 2020, but the uncertainty surrounding sequestration will impact their ability to secure funding for long-term projects that extend into 2021 and beyond.

Technical Solutions

Technical Solutions is Huntington Ingalls newest segment that launched in December 2016. They are a professional services business that provides mission-critical services and practical solutions to a wide variety of governmental and commercial customers. They provide fleet support, mission driven innovation solutions, nuclear & environmental solutions, and oil and gas services. Their year to date revenues are up 1.5 percent to $721 million compared to the same time last year. The increase in revenues was primarily due to higher oil and gas services and mission driven innovative solutions revenues. They were awarded a $34 million contract to provide engineering, technical, repair and logistical support to the US Navy’s Coastal Riverine Forces. This contributes to their total backlog of $746 million, of which $425 million if fully funded. We believe that Technical Solutions has the strongest outlook of the three segments because it has the greatest capability to work with customers that are not tied to the defense budget. They will still be affected by potential sequestration, but they may be able to offset the adversity best.

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(Source: HII Q3 Earnings Release 2)

Government Regulation

Huntington Ingalls is affected by a variety of laws and regulations relating to the award, administration, and performance of US Government contracts. They are routinely audited and reviewed by different governmental agencies including: US Navy’s Supervisor of Shipbuilding, Defense Contract Audit Agency (DCAA), and Defense Contract Management Authority (DCMA). These audits evaluate contract performance, cost structures, adequacy of business systems and compliance with various applicable laws. In the event of a poor review, they may be subject to various fines, penalties, repayments, or other damages. Huntington Ingalls was last fined by the US Government in August 2017 for overbilling. Additionally, the US Government has the authority to terminate contracts with little or no prior warning. The likelihood of the government exercising this authority is very low and we do not consider this a threat to Huntington Ingalls business cycle.

Valuation Summary

Our team arrived at a HOLD rating for Huntington Ingalls Industries after utilizing Discounted Cash Flows (DCF), Economic Profit (EP), Dividend Discount Model (DDM), and Relative Valuation models. Weighting the models 50/25/25 resulted in a price target of $245 to $255.

Revenue Decomposition

Huntington Ingalls reports revenues as product and service sales, but decomposes revenue into its three distinct segments and one intersegment elimination account in its footnotes. The three segments are Ingalls Shipbuilding, Newport News, and Technical Solutions. We took the raw data that was provided in their quarterly and annual reports to derive percentage of total sales and revenue growth for each segment. We utilized these historical trends, along with management guidance and industry trends, to forecast segment revenues and then back into product and service sales.

Ingalls Shipbuilding and Newport New

Our revenue forecasts for 2018 and 2019 are derived from a strong performance to start 2018 and the backlog that continues to be refilled as deliveries are made. Revenues are driven by the number of ship deliveries each year and the percentage completion on unfinished projects. Our revenue forecasts for 2020 and beyond are reflective of

our view that the uncertainty surrounding the defense spending budget with a gridlocked Congress will negatively affect Huntington Ingalls’ growth.

Technical Solutions

We are forecasting Technical Solutions to experience stronger revenue growth compared to the other two segments due to the segment being in the growth stages of its business cycle. Additionally, this segment is best structured to sustain potential defense budget cuts as they are not a pure-play defense contractor.

Cost of Sales

Cost of Products

We forecasted cost of product sales as 80 percent of product sales. Our assumption is based on recent cost of product sales trending towards the 80 percent mark. We utilized the same forecasted percentage throughout our model.

Cost of Services

We assumed forecasted cost of service revenue to be a forward percentage of service revenues. Based on our similar assumption for cost of product sales, we forecasted cost of service revenues to be 83.50 percent of services revenues. We utilized the same forecasted percentage throughout our model.

Capital Expenditures

Management has issued guidance indicating that capital expenditures will be 5 percent of total sales. Going forward, we believe capital expenditures will continue to be 5 percent of revenues. This allows our model to reflect capital expenditures with little risk of significant changes.

Share Repurchases

Huntington Ingalls is in the midst of a $2.2 billion share repurchase program that is set to run through the end of 2022. Through Q3 of 2018, they have spent $1.5 billion on repurchasing over 10 million shares. We do not believe that they will continue repurchasing shares at the rate they have been doing so far this year; share repurchases have totaled $512 million through the first three quarters of 2018. We straight-line forecasted share repurchases for each year through 2022. This forecast brings Huntington Ingalls to exactly $2.2 billion in share repurchases from 2015 to 2022.

Long-term Debt

Valuation Analysis

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We forecast the balance of long-term debt based on a percentage of non-cash assets. We do not believe Huntington Ingalls intends on increasing long-term debt over the course of our forecast period. Additionally, they do not have any principal debt payments due over the course of the forecast period. We forecasted a slight increase in long-term debt at 22.70 percent of non-cash assets to account for debt issuance costs.

Weighted Average Cost of Capital (WACC)

We found the weighted average cost of capital used to discount free cash flows in the DCF analysis to be calculated as 8.29 percent.

Cost of Equity

We calculated the cost of equity using the Capital Asset Pricing Model (CAPM). To do this, we needed the risk-free rate, equity risk premium, and Huntington Ingalls’s raw beta. The risk-free rate of 3.19 percent is the yield on 10-year US Treasury Note. The equity risk premium was derived from the Geometric Average Premium from 1928 to 2017. Finally, the raw beta was calculated using an average of Huntington Ingalls’ weekly betas from the past 2 to 5 years. Using the CAPM< this resulted in a cost of equity of 9.05 percent.

Cost of Debt

The cost of debt was derived from Huntington Ingalls’ yield to maturity on their 10-year corporate bond. This resulted in a pre-tax cost of debt of 4.47 percent. After applying the tax rate of 21 percent, the after tax cost of debt was calculated to be 3.53 percent.

WACC Weights

The market value of debt was estimated by adding up the disclosed market value of long term debt and the present value of operating leases. The market value of equity was estimated by multiplying the current share price by the number of shares outstanding. This results in market value weights of debt and equity to be 13.71 percent and 86.29 percent, respectively. The final calculation resulted in a WACC of 8.29 percent.

Valuation Models

Discounted Cash Flows (DCF) & Economic Profit (EP)

The DCF model is constructed by forecasting the free cash flows of Huntington Ingalls and discounting them back to their present value using the WACC. Both of the models utilize the value drivers of net operating profit less adjusted taxes (NOPLAT) and Invested Capital (IC).

Using these two drivers, we calculated annual free cash flow and economic profit for the individual models. After discounting the free cash flow for each model, we valued the operating assets by adding the cash flows together and adjusting for non-operating assets and liabilities to reach the equity value. We divided the value of equity by the number of current shares outstanding to get an intrinsic value for Huntington Ingalls. After adjusting for the partial year elapsed, the intrinsic stock price for Huntington Ingalls was $233.64. This valuation yield that Huntington Ingalls is undervalued by 4.47 percent.

We believe that the DCF and EP models are a very important factor in determining the most accurate valuation for Huntington Ingalls because it incorporates projected future performance into the price, but we think other models need to be taken into account as well.

Dividend Discount Model

Huntington Ingalls’ management has established that they are committed to increasing their annual dividend every year. For this reason, we believe that the dividend discount model is very important to take into account when determining a final valuation for the company. We assumed a forward dividend payout ratio of 20 percent. This represents an increase in dividend per share as Huntington Ingalls continues to repurchase stock.

This model yields an intrinsic stock price of $254.09 after being adjusted for the partial year. We believe this is an accurate valuation of the company and should be considered when determining the final valuation.

Relative P/E Valuation

Our relative valuation model is comprised of 8 comparable companies in the Aerospace & Defense industry to Huntington Ingalls. The model computes an intrinsic price per share based on 2018 and 2019 forward P/E ratios. This results in stock prices of $281.25 and $284.08, respectively.

We believe that this model provides a good estimate for the intrinsic stock price when couple with other models because it incorporates current market conditions to assumption based models.

Sensitivity Analysis

CV Growth of NOPLAT vs. WACC

We forecast the CV growth of NOPLAT at 1.95 percent. Any changes in this input will be highly sensitive to the DCF and EP valuation. If held constant we can see how variances in the WACC effect our outcome. If more debt

11

or equity were to be issued to help fund internal growth, this would increase WACC, bringing our intrinsic value down. For every .20 percent increase in WACC, the stock value decreases by approximately $3.69. For every .15 percent increase in NOPLAT while WACC remains constant, the stock price increases approximately $1.92.

Risk-Free Rate vs. Equity Risk Premium

The risk-free rate and equity risk premium are used to calculate the WACC that is used in the DCF/EP models. This sensitivity analysis demonstrates the major swings in price per share that would result from the minor alteration of either of these variables. It also demonstrates the effect that rising interest rates would have on the model. An increase in rates by .10 percent would result in approximately $3.70 reduction of stock prices. The equity risk premium is very rarely agreed upon between industry professionals so it is important to analyze the effects of an increase or decrease.

CV ROIC vs. Capital Expenditures (% of Sales)

This analysis shows the effect that a changing CV ROIC applied to the final forecast year has a major impact on stock price. We see the change that 1.50 percent increase in CV ROIC increases share price by about $.90. The changes in capital expenditures as a percentage of sales also show a significant change in price (about $1.45 for every .5 percent move). This can be attributed to Huntington Ingalls’ shrinking cash balance as they return all free cash flows to shareholders.

Effective Tax Rate vs. Beta

Though the Trump Administration passed a new tax bill last year that lowered corporate marginal tax rate to 21 percent, it is still important to analyze any potential changes to a company’s effective tax rate. Due to the minimal change in price per share when keeping beta constant and changing the tax rate, it is evident that Huntington Ingalls is in a good position to withstand changes to any of its tax rates. The beta measures Huntington Ingalls’ risk compared to the market as a whole. A .1 decrease in their beta results in an increase in share price of approximately $16.42. This illustrates that they are highly sensitive to changes in the market.

Cost of Debt vs. Long-Term Debt (% of Non-Cash Assets)

Huntington Ingalls recently refinanced their long-term debt, but it is important to understand the effects that an increased debt load could have on their share price. An increase of long-term debt by 1 percent only results in reduction in stock price by $.19. This illustrates

Huntington Ingalls solvency and their ability to become more levered if needed. A change in the cost of debt would have a much more significant effect on share price because it is used in the calculation of WACC for the DCF/EP models. A .5 percent decrease in cost of debt would result in an increase in approximately $1.63 to share price.

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1. 2019 Budget Overview - https://dod.defense.gov/Portals/1/Documents/pubs/FY2019-Budget-Request-Overview-Book.pdf

2. HII 2018 Q3 Earnings Release - file:///C:/Users/ecorrigan/Downloads/HII_2018_Q3_Earnings_Release_Final.pdf

3. National Law Review - https://www.natlawreview.com/article/implications-2018-midterm-elections-us-national-defense-policy-and-spending

4. Treasury Yield Data - https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

5. Congressional Research Service - https://fas.org/sgp/crs/natsec/R44039.pdf

6. HII 2017 Annual Report - https://www.sec.gov/Archives/edgar/data/1501585/000150158518000006/hii201710-k.htm

7. HII 2018 Q3 Quarterly Report - https://www.sec.gov/Archives/edgar/data/1501585/000150158518000035/hii2018q310-q0930.htm#sB7CE1BEB166E56F2B305504DCFDC5934

8. GD 2017 Annual Report - https://www.sec.gov/Archives/edgar/data/40533/000004053318000008/gd-2017123110k.htm

9. GD 2018 Q3 Quarterly Report – https://www.gd.com/news/press-releases/2018/10/general-dynamics-reports-third-quarter-2018-results

10. LMT 2017 Annual Report - https://www.sec.gov/Archives/edgar/data/936468/000093646818000009/lmtq4201710k.htm

11. NOC 2017 Annual Report - https://www.sec.gov/Archives/edgar/data/1133421/000113342118000005/noc-12312017x10k.htm

12. RTN 2017 Annual Report - https://www.sec.gov/Archives/edgar/data/1047122/000104712218000022/rtn-12312017x10k.htm

13. FRED – Real Gross Domestic Product https://fred.stlouisfed.org/series/GDPC1

14. Bureau of Economic Analysis – Gross Domestic Product 3rd Quarter 2018

https://www.bea.gov/news/2018/gross-domestic-product-3rd-quarter-2018-advance-estimate

15. FRED – 10 Year Treasury Constant Maturity Rate https://fred.stlouisfed.org/series/DGS10

16. CNBC – The Fed https://www.cnbc.com/2018/11/08/fed-is-set-to-keep-rates-on-hold-before-a-hike-later-in-the-year.html

17. CNBC – US 10 Year Treasury https://www.cnbc.com/quotes/?symbol=US10Y

18. Trading Economics – Crude Oil https://tradingeconomics.com/commodity/crude-oil)

19. Bloomberg Finance – West Texas Intermediate (WTI)

20. Industrial Select Sector SPDR ETF (XLI) – Historic Data https://finance.yahoo.com/quote/XLI/

21. Daily FX – Oil Prices Enter Bear Market Even as U.S. Crude Output Hits Record High https://www.dailyfx.com/forex/fundamental/article/special_report/2018/11/09/Oil-Price-Enters-Bear-Market-Even-as-U.S.-Crude-Output-Hits-Record-High.html

22. Investopedia – Purchasing Managers’ Index (PMI) https://www.investopedia.com/terms/p/pmi.asp

23. Investopedia – Base Metals https://www.investopedia.com/terms/b/base-metals.asp

24. Bloomberg Finance - Base Metals Spot Price Index

25. Bloomberg Finance - Manufacturing PMI

26. Trading Economics- United States GDP Growth Rate (Forecast) https://tradingeconomics.com/united-states/gdp-growth/forecast

References

Huntington Ingalls Industries, Inc.Revenue Decomposition(In millions)Fiscal Years Ending Dec. 31 2015 2016 2017 2018E 2019E 2020E 2021E CV 2022Sales and Service Revenues

Ingalls 2,188 2,389 2,420 2,543 2,631 2,709 2,772 2,823 Newport News 4,298 4,089 4,164 4,345 4,495 4,629 4,736 4,823 Technical Solutions 616 691 952 1,017 1,052 1,084 1,109 1,129 Other - - - - - - - - Intersegment eliminations (82) (101) (95) (104) (107) (110) (113) (115)

Total Sales and Service revenues 7,020 7,068 7,441 7,794 8,063 8,303 8,495 8,652

Sales and Service Revenues %Ingalls 30.81% 33.32% 32.11% 33.75% 34.91% 35.95% 36.78% 37.46%Newport News 60.52% 57.04% 55.25% 57.66% 59.65% 61.42% 62.85% 64.00%Technical Solutions 8.67% 9.64% 12.63% 13.50% 13.96% 14.38% 14.71% 14.98%Other 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Intersegment eliminations -1.15% -1.41% -1.26% -1.38% -1.42% -1.47% -1.50% -1.53%

Sales and Service Revenues GrowthIngalls -4.29% 9.19% 1.30% 5.10% 3.45% 2.97% 2.32% 1.84%Newport News -5.25% -4.86% 1.83% 4.36% 3.45% 2.97% 2.32% 1.84%Technical Solutions 0.00% 12.18% 37.77% 6.85% 3.45% 2.97% 2.32% 1.84%Other -100.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Intersegment eliminations 4000.00% 23.17% -5.94% 9.12% 3.45% 2.97% 2.32% 1.84%

Total Sales and Service revenues 0.91% 0.68% 5.28% 4.75% 3.45% 2.97% 2.32% 1.84%

Huntington Ingalls Industries, Inc.Income Statement(in Millions)Fiscal Years Ending Dec. 31 2015 2016 2017 2018E 2019E 2020E 2021E 2022ESales and Service Revenue

Product sales 5,665 5,631 5,573 5,838 6,039 6,218 6,363 6,480 Service revenues 1,355 1,437 1,868 1,957 2,024 2,084 2,133 2,172

Total sales & service revenues 7,020 7,068 7,441 7,794 8,063 8,303 8,495 8,652 Cost of Sales and Service Revenues

Cost of product sales 4,165 4,217 4,279 4,482 4,626 4,753 4,852 4,929 Cost of service revenues 1,172 1,205 1,534 1,598 1,658 1,712 1,755 1,790

Gross Margin 1,683 1,646 1,628 1,715 1,779 1,838 1,889 1,933 Depreciation of PP&E 154 163 165 188 205 222 239 254 Amortization of Intangibles 26 23 40 36 32 28 26 24 Income (loss) from operating investments, net 10 6 12 12.6 13.0 13.4 13.7 14.0 Other income & gains - 15 - - - - - - General & administrative expenses 669 623 570 585 564 540 510 519 Goodwill impairment 75 - - - - - - -

Operating income (loss) 769 858 865 893 964 1,035 1,101 1,121 Other Income (Expense)

Interest expense (137) (74) (94) (59) (58) (59) (61) (63)Other, net - - 1 - - - - -

Earnings (loss) before income taxes 632 784 772 834 907 976 1,040 1,058 Federal and foregin income taxes 228 211 293 150 163 176 187 191

Net earnings (loss) 404 573 479 684 744 800 853 868

Basic earnings (loss) per share 8.43 12.24 10.48 15.51 17.45 19.20 20.88 21.66 Weighted average common shares outstanding 47.90 46.80 45.70 44.09 42.61 41.69 40.85 40.07

Year End Shares Outsanding 46.90 46.20 45.10 43.09 42.13 41.25 40.44 39.70 Dividends per common share 1.70 2.10 2.52 3.02 3.49 3.84 4.18 4.33

Dividend Payout Ratio 20.17% 17.16% 24.05% 19.47% 20.00% 20.00% 20.00% 20.00%EPS Growth 21.65% 45.20% -14.38% 48.03% 12.49% 10.00% 8.80% 3.71%

Huntington Ingalls Industries, Inc.Balance Sheet(in Millions)Fiscal Years Ending Dec. 31 2015 2016 2017 2018E 2019E 2020E 2021E CV 2022Current AssetsCash & cash equivalents 894$ 720$ 701$ 224 317 501 762 1,060 Accounts receivable, net 1,074 1,164 1,188 1,169 1,210 1,245 1,274 1,298 Inventoried costs, net 285 210 183 156 161 166 170 173 Deferred income taxes - - - - - - - - Prepaid expenses & other current assets 31 48 123 117 121 125 127 130 Total current assets 2,284 2,142 2,195 1,666 1,809 2,037 2,334 2,660 Property, Plant and EquipmentProperty, plant & equipment, gross 3,316 3,613 3,985 4,375 4,778 5,193 5,618 6,050 Less: accumulated depreciation & amortization 1,489 1,627 1,770 1,958 2,164 2,386 2,624 2,879 Property, plant & equipment, net 1,827 1,986 2,215 2,416 2,614 2,807 2,993 3,171 Other AssetsGoodwill 956 1,234 1,217 1,217 1,217 1,217 1,217 1,217 Other purchased intangibles, net 495 548 508 472 440 412 386 362 Long-term deferred tax assets 336 314 114 105 96 88 81 75 Miscellaneous other assets 126 128 125 120 124 128 131 133 Total other assets 1,913 2,224 1,964 1,914 1,877 1,845 1,815 1,787 Total assets 6,024$ 6,352$ 6,374$ 5,996 6,300 6,689 7,142 7,619 Current LiabiltiesTrade accounts payable 317$ 316$ 375$ 382 395 407 416 424 Accrued employees' compensation 215 241 245 253 262 270 276 281 Current portion of long-term debt - - - - - - - - Current portion of postretirement plan liabilities 143 147 139 136 138 133 130 127 Current portion of workers' compensation liabilities 227 217 250 257 266 274 280 286 Advance payments & billings in excess of costs incurred 125 166 146 144 149 154 157 160 Provision for contract losses - - - - - - - - Other current liabilities 247 256 236 253 262 270 276 281 Total current liabilities 1,274 1,343 1,391 1,426 1,472 1,507 1,536 1,559 Long-term debt, net of current portion 1,273 1,278 1,279 1,288 1,310 1,358 1,405 1,448 Pension plan liabilities 1,001 1,116 922 447 312 207 137 92 Other postretirement plan liabilities 423 431 414 406 396 384 370 354 Workers' compensation liabilities 460 441 509 510 528 543 556 566 Deferred tax liabilities - - - - - - - - Other long-term liabilities 103 90 101 97 101 104 106 108 Total liabilities 4,534 4,699 4,616 4,174 4,119 4,103 4,110 4,127 Stockholder's EquityCommon stock and Additional paid-in capital 1,979 1,965 1,943 2,009 2,009 2,009 2,009 2,009 Retained earnings (accumulated deficit) 848 1,323 1,687 2,235 2,828 3,467 4,147 4,840 Treasury stock (492) (684) (972) (1,522) (1,756) (1,990) (2,224) (2,458) Accumulated other comprehensive income (loss) (845) (951) (900) (900) (900) (900) (900) (900) Total stockholders' equity (deficit) 1,490 1,653 1,758 1,822 2,181 2,586 3,032 3,491 Total Liabilities and Stockholders' Equity 6,024$ 6,352$ 6,374$ 5,996 6,300 6,689 7,142 7,619

Huntington Ingalls Industries, Inc.Cash Flow Statement(In Millions)Fiscal Years Ending Dec. 31 2015 2016 2017Operating ActivitiesNet earnings (loss) 404$ 573$ 479$

Adjustments to reconcile net cash provided by (used in) operating activitiesDepreciation 154 163 165 Amortization of purchased intangibles 26 23 40 Amortization of debt issuance costs 8 5 6 Provision for doubtful accounts - - 10 Stock-based compensation 43 36 34 Excess tax benefit related to stock-based compensation (33) - -Deferred income taxes (15) 85 184 Proceeds from insurance settlement related to investing activities (21) - -Goodwill impairment - - -Impairment of goodwill & intangible assets 102 - -Loss on early extinguishment of debt 44 - 22 Change in:

Accounts receivable (41) (22) (35) Inventoried costs 54 75 18 Prepaid expenses & other assets (31) (17) (52) Accounts payable & accruals 97 (41) 102 Retiree benefits 32 (44) (163)

Other non-cash transactions, net 5 (14) 4 Net cash flows from operating activities 828 822 814 Investing Activities

Capital expenditure additions (188) (285) (382) Grant proceeds for capital expenditures - - 21 Proceeds from disposition of assets 32 4 9 Acquisition of businesses, net of cash received (6) (372) 3 Proceeds from insurance settlement related to investing activities 21 - -

Net cash flows from investing activities (141) (653) (349) Financing Activities

Proceeds from issuance of long-term debt 600 - 600 Repayment of long-term debt (995) - (600) Debt issuance costs (21) - (12) Tender premiums & fees related to early extinguishment of debt (33) - (15) Dividends paid (81) (98) (115) Repurchases of common stock (232) (194) (286) Employee taxes on certain share-based payment arrangements (54) (51) (56) Proceeds from stock option excercises - - -Excess tax benefit related to stock-based compensation 33 - -Repayment of notes payable to former parent & accrued interest - - -Dividend to former parent in connection with spin-off - - -Net transfers from (to) former parent - - -

Net cash flows from financing activities (783) (343) (484) Change in cash & cash equivalents (96) (174) (19) Cash & cash equivalents, beginning of year 990 894 720 Cash & cash equivalents, end of year 894$ 720$ 701$

Huntington Ingalls Industries, Inc.Cash Flow Statement(In Millions)Fiscal Years Ending Dec. 31 2018E 2019E 2020E 2021E CV 2022Cash Flows from Operating ActivitiesNet Earnings (loss) 684 744 800 853 868 Adjustments to Reconcile Net Income

Depreication of PPE 188 205 222 239 254 Amortization of Intangible Assets 36 32 28 26 24 Change in Deferred Taxes 9 8 8 7 7 Change in Working Capital Accounts:

Accounts receivable, net 19 (40) (36) (29) (23)Inventoried costs, net 27 (5) (5) (4) (3)Prepaid expenses & other current assets 6 (4) (4) (3) (2)Trade accounts payable 7 13 12 9 8 Accrued employees' compensation 8 9 8 6 5 Current portion of postretirement plan liabilities (3) 2 (5) (3) (3)Current portion of workers' compensation liabilities 7 9 8 6 5 Advance payments & billings in excess of costs incurred (2) 5 4 4 3 Other current liabilities 17 9 8 6 5

Other Long-term Liabilities (4) 3 3 2 2 Long Term Workers' compensation Liabilities 1 18 16 13 10

Net Cash Provided by Operating Activities 1,002 1,007 1,067 1,133 1,159 Cash Flows from Investing Activities

Capital Expenditures (390) (403) (415) (425) (433) Pension Plan Investments (475) (135) (105) (70) (45) Postretirement Plan Investments (8) (10) (12) (14) (16) Miscellaneous Investments 5 (4) (4) (3) (2)

Net Cash Used in Investing Activities (868) (552) (536) (512) (496) Cash Flows from Financing Activities

Proceeds from Issuance of Debt 9 23 48 47 43 Proceeds from ESOP 66 - - - - Dividends Paid (136) (150) (162) (172) (175) Repurchases of Common Stock (550) (234) (234) (234) (234)

Net Cash Used in Financing Activities (611) (362) (348) (360) (366) Change in Cash & Cash Equivalents (477) 93 184 262 297 Beginning Cash & Cash Equivalents Balance 701 224 317 501 762 Ending Cash & Cash Equivalents Balance 224$ 317$ 501$ 762$ 1,060$

Huntington Ingalls Industries, Inc.Common Size Income Statement(in millions)Fiscal Years Ending Dec. 31 2015 2016 2017 2018E 2019E 2020E 2021E CV 2022Sales and Service Revenue

Product sales 80.70% 79.67% 74.90% 74.90% 74.90% 74.90% 74.90% 74.90%Service revenues 19.30% 20.33% 25.10% 25.10% 25.10% 25.10% 25.10% 25.10%

Total sales & service revenues 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%Cost of Sales and Service Revenues

Cost of product sales 59.33% 59.66% 57.51% 57.50% 57.37% 57.24% 57.11% 56.98%Cost of service revenues 16.70% 17.05% 20.62% 20.50% 20.57% 20.62% 20.66% 20.68%

Gross Margin 23.97% 23.29% 21.88% 22.00% 22.07% 22.13% 22.24% 22.34%Depreciation of PP&E 2.19% 2.31% 2.22% 2.42% 2.55% 2.68% 2.81% 2.94%Amortization of Intangibles 0.37% 0.33% 0.54% 0.46% 0.40% 0.34% 0.31% 0.28%Income (loss) from operating investments, net 0.14% 0.08% 0.16% 0.16% 0.16% 0.16% 0.16% 0.16%Other income & gains 0.00% 0.21% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%General & administrative expenses 9.53% 8.81% 7.66% 7.50% 7.00% 6.50% 6.00% 6.00%Goodwill impairment 1.07% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Operating income (loss) 10.95% 12.14% 11.62% 11.46% 11.96% 12.46% 12.96% 12.96%Other Income (Expense) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Interest expense -1.95% -1.05% -1.26% -0.76% -0.71% -0.71% -0.71% -0.73%Other, net 0.00% 0.00% 0.01% 0.00% 0.00% 0.00% 0.00% 0.00%

Earnings (loss) before income taxes 9.00% 11.09% 10.37% 10.70% 11.25% 11.75% 12.25% 12.23%Federal and foregin income taxes 3.25% 2.99% 3.94% 1.93% 2.02% 2.12% 2.20% 2.20%

Net earnings (loss) 5.75% 8.11% 6.44% 8.78% 9.22% 9.64% 10.04% 10.03%

Huntington Ingalls Industries, Inc.Common Size Balance Sheet - Assets(In Millions)Fiscal Years Ending Dec. 31 2015 2016 2017 2018E 2019E 2020E 2021E CV 2022Current AssetsCash & cash equivalents 14.84% 11.34% 11.00% 3.74% 11.13% 10.48% 9.81% 13.91%Accounts receivable, net 17.83% 18.32% 18.64% 19.50% 19.20% 18.62% 17.84% 17.03%Inventoried costs, net 4.73% 3.31% 2.87% 2.60% 2.56% 2.48% 2.38% 2.27%Deferred income taxes 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Prepaid expenses & other current assets 0.51% 0.76% 1.93% 1.95% 1.92% 1.86% 1.78% 1.70%Total current assets 37.92% 33.72% 34.44% 27.78% 28.71% 30.45% 32.68% 34.92%Property, Plant and EquipmentsLand & land improvements 4.02% 3.97% 4.58% 0.00% 0.00% 0.00% 0.00% 0.00%Buildings & leasehold improvements 26.21% 27.58% 30.17% 0.00% 0.00% 0.00% 0.00% 0.00%Machinery & other equipment 21.83% 22.20% 24.46% 0.00% 0.00% 0.00% 0.00% 0.00%Capitalized software costs 2.99% 3.13% 3.31% 0.00% 0.00% 0.00% 0.00% 0.00%Property, plant & equipment, gross 55.05% 56.88% 62.52% 72.96% 75.83% 77.63% 78.65% 79.42%Less: accumulated depreciation & amortization 24.72% 25.61% 27.77% 32.66% 34.34% 35.67% 36.75% 37.79%Property, plant & equipment, net 30.33% 31.27% 34.75% 40.30% 41.49% 41.97% 41.91% 41.63%Other AssetsGoodwill 15.87% 19.43% 19.09% 20.30% 19.32% 18.19% 17.04% 15.97%Other purchased intangibles, net 8.22% 8.63% 7.97% 7.87% 6.98% 6.16% 5.40% 4.75%Pension plan assets 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Debt issuance costs, net 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Long-term deferred tax assets 5.58% 4.94% 1.79% 1.75% 1.53% 1.32% 1.14% 0.98%Miscellaneous other assets 2.09% 2.02% 1.96% 2.00% 1.97% 1.91% 1.83% 1.75%Total other assets 31.76% 35.01% 30.81% 31.92% 29.80% 27.59% 25.41% 23.45%Total assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%Current LiabiltiesTrade accounts payable 5.26% 4.97% 5.88% 6.37% 6.27% 6.08% 5.83% 5.56%Accrued employees' compensation 3.57% 3.79% 3.84% 4.22% 4.16% 4.03% 3.87% 3.69%Current portion of long-term debt 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Current portion of postretirement plan liabilities 2.37% 2.31% 2.18% 2.27% 2.19% 1.99% 1.82% 1.67%Current portion of workers' compensation liabilities 3.77% 3.42% 3.92% 4.29% 4.22% 4.10% 3.93% 3.75%Advance payments & billings in excess of costs incurred 2.08% 2.61% 2.29% 2.40% 2.37% 2.30% 2.20% 2.10%Provision for contract losses 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Other current liabilities 4.10% 4.03% 3.70% 4.22% 4.16% 4.03% 3.87% 3.69%Total current liabilities 21.15% 21.14% 21.82% 23.78% 23.37% 22.53% 21.51% 20.46%Long-term debt, net of current portion 21.13% 20.12% 20.07% 21.48% 20.80% 20.30% 19.67% 19.01%Pension plan liabilities 16.62% 17.57% 14.47% 7.45% 4.95% 3.09% 1.92% 1.21%Other postretirement plan liabilities 7.02% 6.79% 6.50% 6.77% 6.29% 5.74% 5.18% 4.65%Workers' compensation liabilities 7.64% 6.94% 7.99% 8.51% 8.38% 8.12% 7.78% 7.43%Deferred tax liabilities 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Other long-term liabilities 1.71% 1.42% 1.58% 1.62% 1.60% 1.55% 1.49% 1.42%Total liabilities 75.27% 73.98% 72.42% 69.62% 65.38% 61.35% 57.54% 54.18%Stockholder's EquityCommon stock 32.85% 30.94% 30.48% 33.51% 31.89% 30.03% 28.13% 26.37%Retained earnings (accumulated deficit) 14.08% 20.83% 26.47% 37.27% 44.89% 51.82% 58.07% 63.53%Treasury stock -8.17% -10.77% -15.25% -25.38% -27.87% -29.75% -31.14% -32.26%Accumulated other comprehensive income (loss) -14.03% -14.97% -14.12% -15.01% -14.28% -13.45% -12.60% -11.81%Total stockholders' equity (deficit) 24.73% 26.02% 27.58% 30.38% 34.62% 38.65% 42.46% 45.82%Total Liabilities and Stockholders' Equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Huntington Ingalls Industries, Inc.Common Size Balance Sheet - Sales(In Millions)Fiscal Years Ending Dec. 31 2015 2016 2017 2018E 2019E 2020E 2021E CV 2022Current AssetsCash & cash equivalents 12.74% 10.19% 9.42% 2.87% 3.93% 6.03% 8.97% 12.25%Accounts receivable, net 15.30% 16.47% 15.97% 15.00% 15.00% 15.00% 15.00% 15.00%Inventoried costs, net 4.06% 2.97% 2.46% 2.00% 2.00% 2.00% 2.00% 2.00%Deferred income taxes 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Prepaid expenses & other current assets 0.44% 0.68% 1.65% 1.50% 1.50% 1.50% 1.50% 1.50%Total current assets 32.54% 30.31% 29.50% 21.37% 22.43% 24.53% 27.47% 30.75%Property, Plant and EquipmentsLand & land improvements 3.45% 3.57% 3.92% 0.00% 0.00% 0.00% 0.00% 0.00%Buildings & leasehold improvements 22.49% 24.79% 25.84% 0.00% 0.00% 0.00% 0.00% 0.00%Machinery & other equipment 18.73% 19.95% 20.95% 0.00% 0.00% 0.00% 0.00% 0.00%Capitalized software costs 2.56% 2.82% 2.84% 0.00% 0.00% 0.00% 0.00% 0.00%Property, plant & equipment, gross 47.24% 51.12% 53.55% 56.13% 59.25% 62.55% 66.13% 69.93%Less: accumulated depreciation & amortization 21.21% 23.02% 23.79% 25.12% 26.83% 28.74% 30.89% 33.28%Property, plant & equipment, net 26.03% 28.10% 29.77% 31.00% 32.42% 33.81% 35.23% 36.66%Other AssetsGoodwill 13.62% 17.46% 16.36% 15.61% 15.09% 14.66% 14.33% 14.07%Other purchased intangibles, net 7.05% 7.75% 6.83% 6.06% 5.46% 4.96% 4.54% 4.18%Pension plan assets 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Debt issuance costs, net 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Long-term deferred tax assets 4.79% 4.44% 1.53% 1.34% 1.19% 1.07% 0.96% 0.86%Miscellaneous other assets 1.79% 1.81% 1.68% 1.54% 1.54% 1.54% 1.54% 1.54%Total other assets 27.25% 31.47% 26.39% 24.55% 23.28% 22.23% 21.37% 20.65%Total assets 85.81% 89.87% 85.66% 76.93% 78.14% 80.56% 84.07% 88.06%Current LiabiltiesTrade accounts payable 4.52% 4.47% 5.04% 4.90% 4.90% 4.90% 4.90% 4.90%Accrued employees' compensation 3.06% 3.41% 3.29% 3.25% 3.25% 3.25% 3.25% 3.25%Current portion of long-term debt 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Current portion of postretirement plan liabilities 2.04% 2.08% 1.87% 1.74% 1.71% 1.60% 1.53% 1.47%Current portion of workers' compensation liabilities 3.23% 3.07% 3.36% 3.30% 3.30% 3.30% 3.30% 3.30%Advance payments & billings in excess of costs incurred 1.78% 2.35% 1.96% 1.85% 1.85% 1.85% 1.85% 1.85%Provision for contract losses 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Other current liabilities 3.52% 3.62% 3.17% 3.25% 3.25% 3.25% 3.25% 3.25%Total current liabilities 18.15% 19.00% 18.69% 18.29% 18.26% 18.15% 18.08% 18.02%Long-term debt, net of current portion 18.13% 18.08% 17.19% 16.52% 16.25% 16.36% 16.54% 16.74%Pension plan liabilities 14.26% 15.79% 12.39% 5.73% 3.87% 2.49% 1.61% 1.06%Other postretirement plan liabilities 6.03% 6.10% 5.56% 5.21% 4.91% 4.62% 4.36% 4.09%Workers' compensation liabilities 6.55% 6.24% 6.84% 6.54% 6.54% 6.54% 6.54% 6.54%Deferred tax liabilities 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Other long-term liabilities 1.47% 1.27% 1.36% 1.25% 1.25% 1.25% 1.25% 1.25%Total liabilities 64.59% 66.48% 62.03% 53.55% 51.09% 49.42% 48.38% 47.71%Stockholder's EquityCommon stock 28.19% 27.80% 26.11% 25.78% 24.92% 24.20% 23.65% 23.22%Retained earnings (accumulated deficit) 12.08% 18.72% 22.67% 28.67% 35.07% 41.75% 48.82% 55.94%Treasury stock -7.01% -9.68% -13.06% -19.53% -21.78% -23.97% -26.18% -28.41%Accumulated other comprehensive income (loss) -12.04% -13.46% -12.10% -11.55% -11.16% -10.84% -10.59% -10.40%Total stockholders' equity (deficit) 21.23% 23.39% 23.63% 23.37% 27.05% 31.14% 35.69% 40.35%Total Liabilities and Stockholders' Equity 85.81% 89.87% 85.66% 76.93% 78.14% 80.56% 84.07% 88.06%

Huntington Ingalls Industries, Inc.Value Driver Estimation(in millions)Fiscal Years Ending Dec. 31 2015 2016 2017 2018E 2019E 2020E 2021E CV 2022EBITA

Net Sales 7,020 7,068 7,441 7,794 8,063 8,303 8,495 8,652 - Cost of Products Sold 4,165 4,217 4,279 4,482 4,626 4,753 4,852 4,929 -Cost of Services 1,172 1,205 1,534 1,598 1,658 1,712 1,755 1,790 -SG&A 669 623 570 585 564 540 510 519 -Depreciation 154 163 165 188 205 222 239 254 -Amortization of Non-Goodwill Intangibles 34 28 46 36 32 28 26 24 +Implied Interest on Operating Leases 6 7 8 7 8 9 9 10

EBITA 832 839 855 913 985 1,057 1,124 1,145

LESS: Adjusted TaxesIncome Tax Provision 228 211 293 150 163 176 187 191 +Tax Shield on Interest Expense 48 26 33 12 12 12 13 13 +Tax Shield on Amortized Goodwill 26 - - - - - - - +Tax Shield on Implied Operating lease Interest 2 3 3 2 2 2 2 2 +Tax Shield on Non-Operating Losses - - - - - - - -

Total Ajdusted Taxes 304 239 329 164 177 190 202 206

Plus: Change in Deferred Taxes (15) 85 184 9 8 8 7 7

NOPLAT: EBITA - Adjusted Taxes + Change in Deferred Taxes 513 685 710 758 817 875 929 946

Operating Current AssetsNormal Cash 227 225 223 224 242 249 255 259 Accounts Receivable 1,074 1,164 1,188 1,169 1,210 1,245 1,274 1,298 Inventory 285 210 183 156 161 166 170 173 Prepaid Expenses 31 48 123 117 121 125 127 130

Operating Current Assets 1,617 1,647 1,717 1,666 1,733 1,785 1,826 1,860

Operating Current LiabilitiesAccounts Payable 317 316 375 382 395 407 416 424 Accrued employees' compensation 215 241 245 253 262 270 276 281 Advance payments & billings in excess of costs incurred 125 166 146 144 149 154 157 160 Provision for contract losses - - - - - - - - Other current liabilities 247 256 236 253 262 270 276 281

Operating Current Liabilities 904 979 1,002 1,033 1,068 1,100 1,126 1,146

Net Working Capital 713 668 715 633 665 685 701 713 + Net PPE 1,827 1,986 2,215 2,416 2,614 2,807 2,993 3,171 + Net Intangible Assets 495 548 508 472 440 412 386 362 + PV of Operating Leases 165 171 165 180 195 210 223 237 - Other Operating Liabilities 103 90 101 97 101 104 106 108

Invested Capital 3,097 3,283 3,502 3,605 3,813 4,010 4,197 4,375

NOPLAT 513 685 710 758 817 875 929 946 Beginning Invested Capital 3,531 3,097 3,283 3,502 3,605 3,813 4,010 4,197 ROIC 14.52% 22.12% 21.63% 21.65% 22.66% 22.94% 23.18% 22.54%

Beginning Invested Capital 3,531 3,097 3,283 3,502 3,605 3,813 4,010 4,197 Spread (ROIC WACC) 6.23% 13.83% 13.34% 13.36% 14.37% 14.65% 14.89% 14.25%EP 220 428 438 468 518 559 597 598

NOPLAT 513 685 710 758 817 875 929 946 CapEx (Change in IC) (434) 186 219 102 209 196 188 178 FCF 947 499 491 656 608 679 742 768

Huntington Ingalls Industries, Inc.Weighted Average Cost of Capital (WACC) Estimationas of 10/22/2018

Cost of Equity 9.05%Risk-Free Rate 3.19%Equity Risk Premium 4.80%Beta 1.22

After-Tax Cost of Debt 3.53%Pre-Tax 4.47%Marginal Tax Rate 21.00%

Market Value of Equity 9,606.73$ Share Price 223.65$ Common Shares Outstanding 42.95

Market Value of Debt 1,526.34$ Long-Term Debt 1,361.00$ PV of Operating Leases 165.34$

Market Weights% Equity 86.29%% Debt 13.71%

WACC 8.29%

Huntington Ingalls Industries, Inc.Discounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models

Key Inputs: CV Growth 1.95% CV ROIC 20.08% WACC 8.29% Cost of Equity 9.05%

Fiscal Years Ending Dec. 31 2018E 2019E 2020E 2021E CV 2022

DCF ModelPeriod 1 2 3 4 5NOPLAT 758 817 875 929 946 Capex 102 209 196 188 178 Free Cash Flow (FCF) 656 608 679 742 768 Continuiing Value (CV) 13,472

Discount Period 1 2 3 4 4PV of FCF 606 519 534 539 9,797

Value of Operating Assets 11,995 Add: Excess Cash 478 Less: Debt (1,361) Less: PV of Operating Leases (165) Less: Unfunded Portion of Pension Plan (941) Less: Unfunded Portion of Other Postretirement Benefits (553) Less: ESOP (35) Value of Equity 9,418 Shares Outsanding 42.95Intrinsic Value per Share 219.25$

EP ModelPeriod 1 2 3 4 5NOPLAT 758 817 875 929 946 Beginning Invested Capital 3,502 3,605 3,813 4,010 4,197 ROIC 21.65% 22.66% 22.94% 23.18% 22.54%WACC 8.29% 8.29% 8.29% 8.29% 8.29%Economic Profit (EP) 468 518 559 597 598 Continuiing Value (CV) 9,275 Discount Period 1 2 3 4 4PV of EP 432 442 440 434 6,745

Value of EP 8,493 Plus: Beginning Invested Capital 3,502 Value of Operating Assets 11,995 Add: Excess Cash 478 Less: Debt (1,361) Less: PV of Operating Leases (165)

Less: Unfunded Portion of Pension Plan (941) Less: Unfunded Portion of Other Postretirement Benefits (553) Less: ESOP (35) Value of Equity 9,418 Shares Outstanding 42.95Intrinsic Value per Share 219.25

Adjusted Value Per Share 233.64$

R* 7.70%

Model Date 11/9/2018Next FYE 12/31/2018Last FYE 12/31/2017Days in FY 365 Days to FYE 313 Elapsed Fraction 0.858

Huntington Ingalls Industries, Inc.Dividend Discount Model (DDM) or Fundamental P/E Valuation Model

Fiscal Years Ending 2018E 2019E 2020E 2021E CV 2022

EPS 15.51$ 17.45$ 19.20$ 20.88$ 21.66$ EPS Growth 12.49% 10.00% 8.80% 3.71%

Key Assumptions CV growth 3.00% CV ROE 28.62% Cost of Equity 9.05%

Future Cash Flows P/E Multiple (CV Year) 14.81 EPS (CV Year) 21.66$

Dividends per Share 3.02 3.49 3.84 4.18 19.39 Future Stock Price 320.71$ Future Cash Flows

Discount Periods 1 2 3 4 4 Discounted Cash Flows 2.77$ 2.94$ 2.96$ 2.95$ 226.82$

Intrinsic Value per Share 238.44$ Adjusted Value Per Share 254.09$

R* 7.70%

Model Date 11/9/2018Next FYE 12/31/2018Last FYE 12/31/2017Days in FY 365 Days to FYE 313 Elapsed Fraction 0.858

Huntington Ingalls Industries, Inc.Relative Valuation Models

EPS EPSTicker Company Price 2018E 2019E P/E 18 P/E 19NOC Norhtrop Grumman Cor 285.73$ 17.99$ 18.37$ 15.88 15.55 GD General Dynamics Corp 184.50$ 11.13$ 12.18$ 16.58 15.15 LMT Lockheed Martin Corp 313.12$ 17.50$ 19.53$ 17.89 16.03 LLL L3 Technologies 195.38$ 10.14$ 11.60$ 19.27 16.84 COL Rockwell Collins 133.22$ 6.89$ 7.61$ 19.34 17.51 HRS Harris Corporation 153.14$ 7.87$ 8.96$ 19.46 17.09 TXT Textron, Inc 56.88$ 3.21$ 3.58$ 17.72 15.89 RTN Raytheon Company 188.02$ 9.95$ 11.63$ 18.90 16.17

Average 18.13 16.28

HII Huntington Ingalls Indus $223.65 15.51 17.45 14.42 12.82

Implied Relative Value: P/E (EPS18) $ 281.25 P/E (EPS19) 284.08$

Huntington Ingalls Industries, Inc.Key Management Ratios

Fiscal Years Ending 2015 2016 2017 2018E 2019E 2020E 2021E CV 2022Formulas

Liquidity RatiosCurrent Ratio Current Asset/Current Liabilities 1.79 1.59 1.58 1.17 1.23 1.35 1.52 1.71Quick Ratio (Cash + ST Investments + Receivables)/(Current Liabilities) 1.54 1.40 1.36 0.98 1.04 1.16 1.33 1.51Cash Ratio Cash/Current Liabilities 0.70 0.54 0.50 0.16 0.22 0.33 0.50 0.68

Activity or Asset-Management RatiosRecievables Turnover Total Revenue/Beginning Receivables 20.71 24.80 35.43 42.59 51.73 51.49 51.16 50.92Day's Recievable 365/Receivables Turnover 17.63 14.72 10.30 8.57 7.06 7.09 7.13 7.17Inventory Turnover Cost of Products/Beginning Inventory 12.29 14.80 20.38 24.49 29.67 29.47 29.22 29.01

Financial Leverage RatiosDebt Ratio Total Debt/Total Assets 0.75 0.74 0.72 0.70 0.65 0.61 0.58 0.54Debt to Equity Ratio Total Debt/Total Equity 3.04 2.84 2.63 2.29 1.89 1.59 1.36 1.18

Profitability RatiosGross Margin (Total Revenue - COGS)/Total Revenue 23.97% 23.29% 21.88% 22.00% 22.07% 22.13% 22.24% 22.34%ROA Net Income/Average Total Assets 5.50% 6.53% 9.01% 7.74% 11.13% 11.45% 11.57% 11.56%Profit Margin Net income/Total Revenue 5.75% 8.11% 6.44% 8.78% 9.22% 9.64% 10.04% 10.03%ROE Net Income/Beginning Shareholders' Equity 29.60% 38.46% 28.98% 38.91% 40.81% 36.69% 32.99% 28.62%

Payout Policy RatiosDividend Payout Ratio Dividend/EPS 20.17% 17.16% 24.05% 19.47% 20.00% 20.00% 20.00% 20.00%Retention Ratio 1 - Dividend Payout Ratio 79.83% 82.84% 75.95% 80.53% 80.00% 80.00% 80.00% 80.00%Total Payout Ratio (Total Dividends + Repurchases)/Net Income 78.25% 50.70% 84.43% 100.31% 51.69% 49.45% 47.63% 47.14%