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We have maintained our Neutral recommendation on Northrop Grumman Corporation (NOC - Analyst Report) on May 22, 2013 on the back of its improved performance and lower share count that led to a top and bottom line beat in the first quarter. However, offsetting these positive factors to some extent is the uncertainty related to the defense budget. The company currently has a Zacks Rank #3 (Hold).

Why the Reiteration?

Northrop Grumman posted strong first quarter 2013 results with both the top and bottom line beating the Zacks Consensus Estimate. The results were driven by an improved performance and share buybacks.

During first quarter 2013, cost of products and services decreased to $4.78 billion from $4.84 billion in the prior-year quarter. General and administrative expenses also declined to $558 million from $561.0 million in the year-ago quarter. In order to improve its cost competitiveness, the company is closing and consolidating numerous facilities.

Also during the quarter, the company repurchased 6.5 million shares of its common stock for approximately $456 million. However, this is not the end. Recently, the Board of Directors of Northrop Grumman has approved of an additional repurchase of the company's common stock worth $4 billion. With this new approval, the company currently has total outstanding share repurchase authorization of $5 billion.

Northrop Grumman has also increased its quarterly dividend by 11% bringing the annualized payout to $2.44 per share from $2.20 per share earlier. The quarterly dividend, after the hike, will come to 61 cents per share, up from the prior payment of 55 cents per share. With the current annual dividend, the company generates a dividend yield of 3.02%. In fact, Northrop Grumman’s strong cash position provides substantial financial flexibility to focus on its cash deployment approach.

Moreover, Northrop Grumman is taking several initiatives to ensure further alignment with its customers' need in order to increase affordability. Also, the company is flooded with a number of sizeable contracts. Northrop Grumman’s total order backlog as of Mar 31, 2013 stood at $39.4 billion. During the first quarter, the company received new contracts worth $4.7 billion.

Going forward, the company offers a strong program portfolio positioned to take advantage of focus areas in the defense space. Although Northrop Grumman like its peers faces uncertainty related to the defense budget, it seems to be immune to some extent to the defense budget cuts. In fact, the President's fiscal year 2014 budget supports some of Northrop’s key programs. For 2014, the proposed budget increased funding for Northrop’s E-2D Advanced Hawkeye by 25%, while 21 EA-18G Growlers funding got a proposal for double financing in comparison to 2013. Meanwhile funding for F-35 was re-affirmed, and programs like SBIRS, Advanced EHF and the James Webb Space Telescope, Global Hawk Block 30 and Block 40 operations were sufficiently funded. Cybersecurity became a key investment area with funding increasing by more than 20% to $4.7 billion.

Despite these positives, apprehension of defense cutbacks on high-cost platform programs, over-exposure to the Department of Defense budget, cost over-runs and reductions in the Afghanistan and Iraq operations compel us to remain on the sidelines.

Stocks to Consider

Stocks worth considering in the space are Erickson Air-Crane Inc. (EAC - Snapshot Report), Wesco Aircraft Holdings, Inc. (WAIR - Snapshot Report) and Alliant Techsystems Inc. (ATK - Analyst Report). While Erickson Air-Crane carries a Zacks Rank #1 (Strong Buy), Wesco Aircraft and Alliant Techsystems hold a Zacks Rank #2 (Buy).

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