Outperform

****

37 points

SAIC (NYSE: SAI)

Outperform

****

26 points

General Dynamics (NYSE: GD)

Outperform

****

15 points

It seems everything defense-related that Cowen touches, turns to gold. And so when the analyst defied conventional wisdom yesterday, and declared that defense contractor Northrop would outperform the market as well, you know I listened up.

According to Cowen, investors have overestimated the risk that the Obama administration poses to defense contractors generally, and Northrop in particular. Cowen's rationale: U.S. contractors operate in the U.S. (natch), therefore spending government money on weapons programs "helps boost the economy" -- a key Obama objective. And while Cowen admits that a drawdown of troop levels in Iraq poses some risk to overall defense spending, Northrop's exposure to Iraq is "limited" in scope.

Meanwhile, Cowen says Northrop has a "hedged portfolio of ramping tactical aircraft work" to help keep its business booming. My own impression of trends in the defense sector tells me that Cowen is right on target here. In particular, Northrop is fast becoming the dominant player in larger unmanned aerial vehicles, one area of the military that President-elect Obama has stated publicly he intends to support and expand.

In addition to all the above, Northrop offers investors an attractive valuation today, even after the post-upgrade run-up. The stock sells for a P/E of less than 10, despite analyst expectations of long-term growth north of 13%, and as a bonus, Northrop is currently generating free cash flows superior to what it reports as net income under GAAP.

Foolish takeaway
It's spotty record elsewhere notwithstanding, defense is one sector Cowen knows well, and its analysis of Northrop is spot on. When this banker tells you to buy Northrop Grumman, you'd be well advised to listen.

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