Despite Budget Cuts, This Is Still My Favorite Stock

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Northrop Grumman (NYSE: NOC  ) recently released its second-quarter financial results. While sales were definitely hampered by continuing budget cuts -- second-quarter sales totaled $6.56 billion compared with $7.26 billion in the prior year period -- Northrop had some promising results as well.

First the bad news...
Since this same time last year, earnings from continued operations decreased from $740 million to $520 million, free cash flow from continuing operations decreased from $476 million to -$128 million, and diluted earnings per share fell from $2.34 to $1.81 -- I know, ouch.

Now the good news...
Operating income increased from $750 million to $841 million, and as a percentage of sales that's an increase from 10.3% to 12.8%. Better news:

2011 Guidance Update (millions, except per-share amounts)



Sales $27,500 $27,000
Segment operating margin % Mid 10% 11%
Operating Margin % 11% Mid 11%
Diluted EPS from continued operations $6.50-$6.70 $6.75-$6.90

Source: Northrop Grumman Investor Relations.

Although Northrop had to adjust its expected sales guidance by $500 million, that's not a huge loss. Additionally, operating margins are better than projected, as is EPS.

Regarding the above, Wes Bush, Northrop's CEO stated, "Our focus on performance, our portfolio and effective cash deployment continues to generate value in a challenging budget environment. While sales for the quarter were affected by several factors, the strong margin rates generated by our businesses largely offset the effects of lower sales. Based on our year-to-date results we are increasing our EPS guidance and maintaining our guidance for cash generation, despite a reduced top line outlook that reflects the realities of our current budget environment." 

What this means for the future
With current budget constraints and pressure to reduce overall spending, the defense sector has definitely taken a hit. But with our nation's security dependant on defense companies, it's highly unlikely that they'll disappear into the future.

Moreover, Northrop has a number of things working in its favor that definitely make it investor-friendly:

  • First, it's allocated $1 billion for repurchases of common stock -- making each stock worth more and showing management believes in the company.
  • Second, its P/E is 8.93 -- that's below competitors Boeing (NYSE: BA  ) , General Dynamics (NYSE: GD  ) , Lockheed Martin (NYSE: LMT  ) , L-3 Communications (NYSE: LLL  ) , Textron (NYSE: TXT  ) , and United Technologies (NYSE: UTX  ) . 
  • Third, Northrop pays a dividend yield of 3.10% -- that's higher than Boeing, General Dynamics, L-3 Communications, Textron, and United Technologies.

Drumroll please...
Although Northrop's recent release isn't exactly all roses, it's not something I'm overly concerned about either. Yes, it has its downsides, but it also has its upsides, and that coupled with Northrop's dividend yield and recent downtick in stock price makes me think now is a great time to get in while the stock is cheap.

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Fool contributor Katie Spence loves it when her favorite stocks are cheap because then she can load up! She owns shares of Northrop Grumman. She does not own shares of any other company mentioned above. The Motley Fool owns shares of General Dynamics, Textron, Lockheed Martin, L-3 Communications Holdings, and Northrop Grumman. Motley Fool newsletter services have recommended buying shares of L-3 Communications Holdings. 

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 28, 2011, at 10:46 AM, backness wrote:

    I like lockheed martin better.

    higer dividend, aggressive buyback and they have the f-35 contract in the bag already.

    For them it will all come down to performance of the program. but free cash flows from the f-35 will mean the lockheed will have the pick of many prize defence companies that are in need of cash to keep open over the next couple years.

    Also my final reason for loving lockheed martin, has only 333M shares on the market, of those 100M are owned by the pension plan. If the stock has a big bump, the amount of money that lockheed will have to pay to the pension fund will be reduced as the contribution level will be decreased.

  • Report this Comment On July 28, 2011, at 11:52 AM, TMFKSpence wrote:

    Hi backness,

    Thank you for your comment. However, you might want to read this:

  • Report this Comment On July 28, 2011, at 2:16 PM, backness wrote:

    I agree that there is risk in this stock and outright cancellation is a posibility.

    However, if you read the transcript from the earnings call, the according to lockheed, the cost of not upgrading to the F-35 is equal (1 trillion for air defence either way).

    Couple that with the fact that the chinese will have a stealth jet in production by 2017 (aprox), the window of opportuinity for the USA to maintain clear air superiority will be lost.

    With air superiority as the cornerstone of the entire military, I see it as unlikely that this project will be fully cancelled.

    Again, there is risk, but the reward for a lockheed shareholder is at least a double, while paying almost 4% dividend (decision about raising dividend will be made in september).

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