Last quarter sounded an ominous note for Northrop Grumman (NYSE:NOC) investors. For the first time in five quarters, the defense contractor failed to "beat estimates," merely matching them instead. And now, here we are starting at a recession, a federal budget strained to the breaking point, and -- potentially -- a dovish President alighting in the Oval Office. In this environment, Northrop must report its Q3 news tomorrow. Good luck.

What analysts say:

  • Buy, sell or waffle? Nineteen analysts give Northrop nine buy ratings and 10 holds.
  • Revenue. On average, they expect to see sales increase 3% to $8.2 billion.
  • Earnings. Profits are predicted to rise a bare 1% to $1.42 per share.

What management says:
Despite all the headwinds, CEO Ronald Sugar sounded an upbeat note when Northrop last reported earnings: "Based on this quarter's solid performance and our $67 billion total backlog, we are on track to achieve our 2008 guidance. The long-term outlook for Northrop Grumman continues to be outstanding." The guidance is for $33 billion in sales, $4.90 to $5.25 per share in earnings, and $1.7 billion to $2.1 billion in free cash flow.

What management does:
Management predicts operating margin to be greater than 8% this year -- yet if you look at the long-term trends, profitability is actually moving in the other direction. Operating margin has been falling for three straight quarters now, and Northrop lags just about every other defense contractor out there.

Lockheed Martin (NYSE:LMT), Textron (NYSE:TXT), L-3 (NYSE:LLL), and Raytheon (NYSE:RTN) have all reaped double-digit operating margins from the recent defense boom. But Northrop? As of this writing, it and Boeing (NYSE:BA) are the only two defense majors operating in the range of single-digit profitability.

Margins

3/07

6/07

9/07

12/07

3/08

6/08

Operating

8.8%

8.9%

9.6%

9.4%

8.6%

8.5%

Net

5.2%

5.2%

5.7%

5.6%

5.1%

5.1%

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
OK, all that sounds pretty bad, right? So let me cheer you up before I close: The news ain't all bad. True, the company faces headwinds. Yes, its profits are trending downwards. But here's the good news -- I think the bad news has already been priced into this stock.

Selling for a mere nine times trailing earnings, most analysts still expect Northrop to grow its profits at nearly 13% per year going forward. While valuations are getting compressed across the board in this sector, that doesn't change the fact that Northrop itself is now looking awfully cheap.

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Fool contributor Rich Smith does not own shares of any company named above. The Motley Fool has a disclosure policy.