April 5 (Bloomberg) -- Huntington Ingalls Industries Inc. stands to loss as much as $194.3 million, more than 40 percent of its potential fee, under the Navy’s latest estimate of overruns for the USS Gerald R. Ford aircraft carrier.
Construction of the Ford, the Navy’s most expensive warship, is likely to exceed by $884 million the shipbuilder’s target contract cost of about $5.2 billion for detailed design and construction, according to Navy officials and the service’s Selected Acquisition Report, obtained after it was delivered to Congress on March 29.
The Ford is intended to be the first in a $40 billion, three-ship class of carriers. Its rising costs have brought questions from Republican Senator John McCain about the Navy program and the shipbuilder’s performance. McCain of Arizona, a member of the Senate Armed Services Committee, has asked the Government Accountability Office for a review.
Huntington’s performance on costs “has stabilized but has a long way to go to turn it around,” Sean Stackley, the Navy’s assistant secretary for acquisition, said in an interview. The company and Navy aren’t in agreement on what the carrier’s final construction cost will be, he said.
Under the carrier contract, the Navy would pick up $689.7 million of the overrun that is now projected as “most likely,” with the remaining $194.3 million subtracted from potential maximum construction fees of $467 million for Huntington Ingalls of Newport News, Virginia. The carrier is about 40 percent complete.
Complex Work Ahead
Huntington Ingalls fell 1 percent to $39.91 at the close in New York trading.
“Reduced fees, especially with so much ahead on this ship, is not a positive for the stock,” Heidi Wood, a Morgan Stanley defense and aerospace analyst in New York said today in an e-mailed statement. Further cost increases on the carrier are likely given the “highly complex integration work yet to be done,” said Wood, who rates Huntington Ingalls as neutral and doesn’t own shares.
The company would earn 50 cents of every dollar it shaves from the $884 million projection, according to Stackley. If costs rise still further, “they are at a point in the contract where they share 50/50,” he said.
“We continue to see improvements in our performance on the carrier,” Huntington Ingalls spokeswoman Beci Brenton said in an e-mailed statement
“Although this is a ‘first-in-class’ ship with the unique challenges, we anticipate we will increase efficiencies and continue to retire risk in the three years that remain until delivery,” Brenton said.
The Ford’s total projected cost has increased 18 percent in four years to $12.3 billion from $10.4 billion, according to Navy budget figures cited by the nonpartisan Congressional Research Service. That includes systems that won’t be provided by Huntington Ingalls, such as the nuclear reactor to power the ship, a dual-band radar from Raytheon Co. and an electromagnetic aircraft-launching system from General Atomics of San Diego.
“There will be some meaningful profit implications for Huntington as such a vast increase implies both parties are due for some pain,” said Wood, who called Stackley “very disciplined” in overseeing costs.
The Navy already has taken action against the shipbuilder. Last year it didn’t let the company bill $75 million in fees because of the overrun projections, and that money has been forfeited, Stackley said.
Other cost-control initiatives include designating a Huntington senior vice president and a superintendent to oversee costs, specifying labor-cost targets and intensely reviewing specifications for the vessel, according to the Navy.
The latest overrun estimate stems from “material cost growth, labor inefficiencies” and increases in one-time engineering costs, according to the Navy document.
The labor “inefficiencies are the result of ‘first of class’ challenges,” including production issues such as the use of thin-plate steel and weld distortion, the Navy wrote.
Huntington Ingalls “has had 10 consecutive months of improvements in meeting cost targets,” Rear Admiral Tom Moore, the Navy’s program executive officer for carriers, said in an interview. “If they continue the trend they are on, I’m comfortable we will come in under the ’most likely’ $884 million estimate.” Still, he said the company won’t meet the original targets.
On labor, the company also is moving closer to the goal of 40 million man-hours on the next carrier, the CVN-79, from an earlier estimate of 53 million, Moore said. “I need to drive them down further.” A man-hour is the work one person does in an hour.
The company would receive the minimum fee allowed, about $196 million, if its performance deteriorates and the construction exceeds a worst-case overrun of $1.1 billion by completion in mid-2015, according to Stackley, who called that an unlikely outcome.
The minimum covers “a couple percent of profit,” he said.
The Navy disclosed in February that it was adding $811 million to the Ford’s budget through 2017 to cover increases, including $273 million directly tied to the construction overrun.
Huntington Ingalls was spun off by Northrop Grumman Corp. in March 2011.
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