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Investors have overreacted to a recent quarterly loss at Northrop Grumman (NYSE:NOC) and the chance of cutbacks in defense spending. Barron's Jay Palmer says this leaves Northrop ready for a 65%+ rebound within 18 months.

Most major defense stocks, including Lockheed Martin (NYSE:LMT), Boeing (NYSE:BA) and General Dynamics (NYSE:GD), have underperformed the market for the past year. Northrop has had the worst showing, losing 58% of its stock value from its 2008 high. The company's surprise Q4 loss didn't help investors feel more confident.

But not all is bad. Northrop has an order backlog of $78B, equal to twice its expected 2009 revenue. Moreover, the 2010 federal budget projects 4% annual increases in defense spending over the next few years. CEO Ron Sugar says "we have looked at adjacent civilian opportunities, but for now we are sitting right where we want to be. We see growth across our divisions and opportunities to boost profit margins."

Northrop is well diversified, and stands to benefit from a budget provision to spend hundreds of millions on a satellite system to monitor climate change, something the company has been working on for years.

The company is trading for just seven times this year's estimated profits, and its dividend yields an attractive 4.6%.

  • Myles Walton, an analyst with Oppenheimer, thinks shares could rise to more than $60 from a recent $34.54. "There may be reasons to worry long term, but the pessimism has been overdone in the short- and medium-term. Even if defense spending has peaked, the drop will hurt some, like Northrop, much less than others."

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  • Northrop Grumman: Q4 EPS of $1.57 beats by $0.02. Revenue of $9.15B vs. $8.9B. Sees 2009 EPS of $5.15-5.40 vs. $5.20 and revenue of $34.5B vs. $33.6B. (PR)
  • Northrop Grumman 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.
Source: Plenty of Upside for Northrop Grumman - Barron's

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