NEW DIRECTIONAL CALL PLAYS
Northrop Grumman Corp. - NOC - close: 162.84 change: +1.68
Stop Loss: 158.45
Target(s): To Be Determined
Current Option Gain/Loss: Unopened
Average Daily Volume = 1.4 million
Entry on March -- at $---.--
Listed on March 18, 2015
Time Frame: Exit prior to May option expiration
New Positions: Yes, see below
Why We Like It:
The United States spends more on its defense budget than any other country in the world. The Budget Control Act of 2011 led to the sequestration budget cuts of $1.2 trillion. Half of that spending reduction is taken out of the U.S. defense budget from 2013-2021 (nine years).
Now pretend you are a defense contractor. You might think that having your biggest customer cut their budget would send your revenues and your stock price lower. That has not been the case for the major defense players. While it is true that many defense companies did see slower sales to the U.S. their stocks have delivered significant gains since the sequester.
I should note that part of the defense cuts have been delayed or amended with various short-term deals in Washington but the sequester is poised to return to full power in 2016. Law makers are already trying to find a way around it.
Meanwhile, both 2013 and 2014 saw stocks like NOC outperform the broader market averages. That relative strength has continued into 2015, even after the recent correction.
According to their company website, "Northrop Grumman is a leading global security company providing innovative systems, products and solutions in unmanned systems, cyber, C4ISR, and logistics and modernization to government and commercial customers worldwide." What does that mean? It means NOC makes bombers, unmanned drones, cyber security solutions, and logistics. If you're curious, C4ISR stands for command, control, communications, computers, intelligence, surveillance, and reconnaissance.
The fact that the world seems to be growing more dangerous, not less dangerous, should be a bullish undercurrent that lifts the defense sector. NOC should benefit because the American public does not have the stomach for another war. That means the U.S. will use more and more unmanned technology like NOC's drones.
NOC has consistently delivered on the earnings front. Not only has NOC beaten expectations but they have raised their guidance the last five quarters in a row.
A key driver has been a push to diversify their customers base so they're not so reliant on the U.S.
The company's Q4 report was released on January 29th. Wall Street was expecting a profit of $2.25 a share on revenues of $5.99 billion. NOC delivered earnings of $2.48 per share, up +17% from a year ago. Revenues slipped -0.8% but came in better than expected at $6.11 billion. Their profit margin improved and their backlog at the end of 2014 was $38.2 billion compared to $37 billion the prior year.
Management raised their 2015 earnings guidance into the $9.20-9.50 range and their revenue guidance up to $23.4-23.8 billion. This is above Wall Street's estimate of $9.12 on revenues of $23.5 billion.
The stock peaked near $172 about four weeks ago. Since then NOC, like most of the defense stocks, have seen a correction. NOC was down -9% from its high as of last Friday's low. Yet the point & figure chart is still bullish and forecasting a long-term target of $210.
We like how NOC has kept the bullish trend of higher lows alive. Now, after consolidating sideways in the $158-162 zone the last few days, the current bounce looks like an potential entry point. Tonight we're suggesting a trigger to buy calls at $163.50.
Caveat: The U.S. Air Force is expected to make a big decision in spring or summer this year. That decision is who will make America's next-generation bomber. The program is called the Long Range Strike-Bomber (LRS-B) and will be worth tens of billions of dollars to the winning contractor. This is a major fight between defense contractors like NOC and rivals Boeing (BA) and Lockheed Martin (LMT). If NOC loses this opportunity it could hurt the stock price.
Trigger @ $163.50
- Suggested Positions -
Buy the MAY $170 CALL (NOC150515C170) current ask $2.10
Option Format: symbol-year-month-day-call-strike