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Aerospace & Defense: Clear Skies Ahead

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Howard A. Rubel
Jefferies & Company Inc.
[email protected]

We believe aerospace stocks are likely to benefit from the ongoing recovery in global traffic and yields. While the Obama Administration’s decision to add resources to the war in Afghanistan will likely put-off an eventual contraction of the overall defense budget, the longer-term outlook for defense stocks remains generally muted.

As the services contemplate the ripple effect that the F-35 delays might have on their fleet planning strategies, we learned this week that the Air Force is looking at a possible F-16 life extension program. Further, the U.S. Navy is reviewing a recent offer from Boeing to build 124 F/A-18s under a multi-year contract that would save the service 10 percent.

We continue to rate the shares of Northrop Grumman (NOC) BUY. Our EPS estimates for 2010 and 2011 remain unchanged at $5.85 and $6.85, respectively. We continue to rate the shares of Boeing BUY, and our EPS estimates for 2010 and 2011 remain unchanged at $4.15 and $4.70, respectively.

Troy J. Lahr
Stifel Nicolaus
[email protected]

The President submitted to Congress a fiscal 2011 request of $549 billion for the core Department of Defense budget. The growth of 3 percent in the core budget was relatively in line with expectations. In addition, there was a $159 billion budget request for wartime supplemental spending in FY11 and another $33 billion in supplemental spending requested for FY10.

The Department of Defense budget for Fiscal Year 11 calls for a 4 percent increase in the support account and a 2 percent increase in the investment account. While the support account is slowly becoming more important to defense companies as they push into services work, the investment accounts remains the bread and butter for companies in the industry.

Outlook (for NOC): We are increasing our 2010 EPS estimate from $5.45 to $6.00 mainly due to a more favorable pension adjustment partially offset by lower sales. We are increasing our 2011 EPS estimate from $6.05 to $6.65 for similar reasons.

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U.S. defense firms may see opportunities in credit-squeezed markets to pick up U.S. assets at historically low price-to-earnings multiples. Companies are also leveraging strong balance sheets to grow organically and acquire new services business. As product development transitions to production program deliveries, it is anticipated that companies will ramp up their services businesses and profitability should improve.

NOC beat the Zacks Consensus Estimate of $1.26 with EPS of $1.37 in the fourth quarter of fiscal 2009. The company offers a strong program portfolio positioned to take advantage of growth areas in the defense space, an improving balance sheet and an ongoing share repurchase program.

Our bullish outlook for the company is supported by favorable projected revenue, diversified revenue and earnings streams with strong growth, and discounted relative valuation metrics. However, this would be offset by lower backlog, loss of key contracts and apprehensions over defense spending under the Obama Administration. Thus, over the near-term, we anticipate the company to perform in line with the broader market.

Joseph B. Nadol III
J.P. Morgan
[email protected]
(212) 622-6548

EPS guidance of $5.70-5.95 was better than our estimate of $5.60, primarily due to the lower assumed pension expense in FY10 ($0.15). Sales guidance of $34.0-34.6 billion was somewhat better than we had expected, and our estimate has moved from the low end to the high end of the range. We do not see sales guidance as especially exciting, however, as management seeks only 2-4% growth in info systems and electronics, no growth in aerospace, and a 3-4% decline in shipbuilding.

NOC guided to 2010 segment operating margin in the low 9% range, reflecting margin improvement across the board, from the 8.7% level in 2009.

We are raising our estimates by $0.20 in FY10 to $5.80 and by $0.95 in FY11 to $7.15 due primarily to lower Financial Accounting Standards/Cost Accounting Standards.


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