Why was I so wrong… okay, I was wary of recommending a defense company given that at the time this seemed to be one of the sectors that would be on Obama’s enemy list… or at the very least, that would have been an unflavored industry during his administration… I have always liked Northrop Grumman, recommended it many times on the show, but we momentarily and stupidly put it in the sell block… now the stock has outperformed, in spite of Obama… with the company just yesterday boosting its quarterly dividend by .03 cents a share… almost as though it is spitting in the President’s face… it is time to parole Northrop Grumman… there is nothing like a dividend raise to tell you that your company is in good shape… it is a signal to investors that the company is confident in its ability to consistently earn more than enough money to keep paying the dividend… which was outsized to begin with… and that signal is especially strong when the economy is in rough shape… and far more companies are slicing their dividends… rather than increasing them.

Why does this stock work even though I feared that it wouldn’t… why does it deserve to be released from the sell block, even though I should have done it earlier… here is what I would say if I had to speak at Northrop Grumman’s defense at its parole hearings… okay… the President may be able to go after the coal companies, the utilities, the credit card companies, the healthcare companies… but defense spending… that is untouchable… the defense contractors make a point of providing jobs in practically every congressional district across the country… making Congress very touchy about the idea about reducing defense spending… and that is only when you take pure cold-hearted self interest into account.. we have not even got into the very bad politics of looking weak in defense.

That is why the proposed 2010 defense budget of $533.7b is 4% larger than the 2009 budget… even if it cuts some programs… the part of defense spending that is most at risk is the supplemental budget… which pays for both Iraq and Afghanistan… where Northrop Grumman exposure is minimum, accounting for just 1% of its revenues… really minimal in the scheme of things… even though it is not a play on us upping the anti in Afghanistan, the fact that we are even putting more boots on the ground… shows that Obama is not a hippie piece nik, who wants to turn swords into unprofitable plow shares… that is what we have John Deere for.

At the same time, many of the projects in the companies backlog are moving into the production phase… the $300b F35 joint strike fighter program, which Northrop provides 25% of the components… entering production…how about the unmanned aerial vehicle contracts, you know the awesome drones… totaling around $9b, Northrop Grumman has a $2.6b backlog in the UAV’s… so we know that it is getting a lot of money there… we ought to have whole aircraft carriers filled with those babies… and finally we are building 8 Virginia class submarines for $5.6B, a project that Northrop Grumman splits with General Dynamics… you never know when the Chicomms might turn into actual communists, we could need a little turns.

In total about 65% of the companies backlogs is expected to convert into revenue in 2009... that is an avalanche of cash coming at you… in addition to being one of the least exposed to the most vulnerable parts of the defense budget… and one of the most exposed to move into production this year… Northrop Grumman also has the most fat to cut… out of the major defense companies… you could say that it is the most sop stick defense contractor… and it has the most room to improve… its margins are among the lowest in the cohort… coming in at a puny 8.6%, I cannot believe that is all that it makes from the sales… it has also been hit by poor performance on a number of contracts… especially in ship building, where management is devoting the most effort in improving the business… it has an aggressive profitability plan which includes rigorous inspection of pipe and electrical work… better supply chain management, which we knows matters… and contract discipline which ought to help bring the companies operating margin in shipbuilding up to 10% from 3%, boy it makes no money on shipbuilding.

On top of that, Northrop Grumman has shifted away from bidding on things like large information technology outsourcing contracts, where the risks are too great… instead focusing on bidding on contracts that it is better able to fulfill and profit from… price to earnings ratio 8.6%… I mean, it trades at a discount to the contractors… which I think is absurd… particularly because the whole group is too cheap anyway… just raised its dividend payout, $1.72... 3.5% yield… based on next years payout, 3.7% yield… it is an accidentally high yielder for heavens sake… you do not see Lockheed Martin paying that kind of dividend… go ask Raytheon if they will give you that kind of dividend… no way… not only is this dividend notoriously big for a defense contractor… it can also answer the trenching question that dividend loving Olivia posed in “Marathon Man”… with a powerful yes… as its expected earnings cover its dividend payout more than 3 times over.

Here is the bottom line…