Northrop's $2.5 Billion Buyback

Despite all the talk of constriction in the credit markets, Wall Street's buyback binge continues.

Earlier this month, we saw both General Dynamics (NYSE:GD) and L-3 Communications (NYSE:LLL) announce sub-billion-buck buybacks. Today, we examine the latest adherent to the "Corporation, buy thyself" philosophy, and it's yet another defense contractor.

Last Thursday, Northrop Grumman (NYSE:NOC) announced a buyback authorization of truly mammoth proportions. At $2.5 billion in size, this buyback could potentially reduce Northrop's share count by approximately 9% if implemented in full. Management characterized the buyback as demonstrative of its "commitment to ... enhancement of shareholder value through share repurchases and dividends." Nice, but can Northrop afford such largesse? And with Iraq settling down and dovish Democrats preparing to alight on the White House lawn, is now really the time to be emptying out Northrop's corporate wallet? These are the questions we'll look at today.

Can it pay?
Northrop would have to finance the purchase. At last report, Northrop had just $713 million cash on hand, against approximately $4 billion in long-term debt. On the other hand, the firm did generate nearly $1.8 billion in free cash flow over the last 12 months. Considering that management promised only to make: "share purchases ... at management's discretion from time to time, depending on market conditions," Northrop can probably find a way to make these repurchases over time.

Should it pay?
Yes. Ideally not all at once, and hopefully at a better price. But, yes, Northrop's decision looks reasonable to me. To see where I'm coming from on this, take a look at how it stacks up against a few of its fellow defense contractors:

As you can see, Northrop is neither the cheapest nor the most expensive stock, neither the pokiest nor the sprightliest grower in this group. Trading for 16 times trailing earnings, and only slightly more versus trailing free cash flow, Northrop boasts both PEG and price-to-free cash flow-to-growth ratios of 1.2.

Foolish takeaway
Basically, I can see why Northrop's board of directors thinks its stock is worth buying at today's price. It's cheaper than some of its rivals. Its dividend yield of 1.8% is higher than most of its peers in the defense industry, so there's no obvious need to hike that. And with the Fed possibly cutting interest rates, I also see why Northrop might not be interested in using excess cash to cut a debt load that's only going to get cheaper. I may not be jump-up-and-down enthusiastic about this buyback, but it looks reasonable to me.