Northrop Grumman is attractive

with surface-to-air missiles, increasing tensions in the Gaza strip, and China & North Korea moving into contracts with Cuba and Venezuela to control Latin America… one has to start thinking defensively,” Regan writes. The direct beneficiary in all of this is the defense contractors, and with already healthy balance sheets they are well positioned to continue to outpace the benchmark.

Regan reminds us that we should not forget about the pre-election Barack Obama sell-off, something that happened in spite of the fact that the defense industry typically outperforms more under Democrats, which has increased the relative attractiveness in valuation.

With this said, the question is: Why Northrop Grumman? To Regan, it is all about expectations. When you look at a company like Raytheon (RTN) or Lockheed Martin (LMT), you see high expectations and high P/E ratios relative to peers. Northrop Grumman (NOC), however, is in a great position, as they really only need to perform as “average” to deserve a higher stock price appreciation. “As the worst performing of the ‘big’ defense contractors in 2008, I believe that it is the year for a turnaround at Northrop,” Regan writes.

One of the primary fears in the defense industry concerns the defense budget spending under newly elected President Barack Obama. Confronted with a massive series of bailouts from the government, there may be a need to cut money from somewhere, and it will most likely be in these big-ticket spending projects offered under more “premium” names. “Northrop Grumman, on the other hand, remains diversified into products that make practical sense for things like reconnaissance and surveillance,” Regan writes. “In other words, Northrop is keeping our soldiers safe. This is an area of spending that likely won’t see cuts under Barack Obama and re-elected Defense Secretary Gates from the Department of Defense.”

Northrop has a safe dividend yield of 3.40 percent at the time of this writing, and trades at a massive discount to the other defense names with a P/E at just 9.4 times earnings. Additionally, they have a strong balance sheet and a FCF per share of $6.22.

The conclusion: With enough cash to make their presence felt, Northrop seems strategically positioned to outperform in 2009. “Not only have they recently consolidated their business units to make things easier to manage, but they are starting to form targeted performance numbers in slower units (such as Ship Systems) to increase the overall efficiency of the company in the long run.”

While trading at a significant discount to their peers, Northrop has become an attractive target for investors looking to place bets on mean reversion in 2009. “With many of the same drivers as other more “popular” names, and none of the aerospace exposure or susceptible budgeting, Northrop Grumman is truly a play for the turnaround,” Regan sums up.