Leeb Defends Northrop

02/21/2003 12:00 am EST


Stephen Leeb

Founder and Research Chairman, Leeb Group

"The fundamentals for defense stocks are compelling," notes Stephen Leeb in Personal Finance . "No matter how the Iraqi conflict is resolved, our war on terrorism will continue. And one thing is certain: we'll continue to need a very strong military. Defense expenditures will continue to rise." Here's the advisor's favorite in the sector.

"Defense expenditures as a percentage of GDP, though in an uptrend, remain well below Cold War levels, leaving a great deal of room for further expansion. Defense stocks have underperformed the market in recent months. If defense expenditures continue to increase, this period of underperformance will represent an exceptional buying opportunity.

"A defense contractor with a very attractive valuation is Northrop Grumman (NOC NYSE). The stock is an exceptional value, and we are adding the shares to our model growth portfolio. With the recently inked acquisition of TRW, Northrop becomes a complete defense company with unassailable stakes in every major defense-related area including electronics and network-centric warfare. We expect profits and cash flow to grow at double-digit rates for the foreseeable future. The fact that the stock trades at a discount to the S&P 500 points to dramatic upside during the next 12 to 18 months.

"The fundamental that stands out is free cash flow, which currently is about $7 a share and is likely to rise to well over $11 a share by mid-decade. Based on its current price, Northrop Grumman sports a forward free cash flow yield of well over 10%. Given that one definition of free cash is how much a company can pay out in a dividend without impairing growth, you can see why we regard Northrop as an overhelming value, especially given the likelihood of at least the partial elimination of double dividend taxation. Buy Northrop Grumman up to $100."

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