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Deutsche Banc's Mecray lifts his Northrop target

A week before terrorists destroyed the World Trade Center and damaged the Pentagon, Deutsche Banc Alex. Brown analyst Chris Mecray encouraged investors to buy Northrop Grumman Corp. shares.

New electronic-warfare and radar systems would boost the No. 4 defense contractor's profit, Mecray said on Sept. 4, and Northrop's stock would climb to US$95 from US$82 in the next six to 12 months.

Now, with the military expected to get much of the US$40 billion in emergency aid approved by Congress since the attacks, Mecray is more bullish. In a report to clients he said the shares may climb to US$120, even after a 23 percent surge since Sept. 11.

"The company has seen a decent run, and it's still significantly cheaper than its peers," Mecray said in an interview. "You look at Northrop, and it's well positioned. The question is what's the right price and what's their outlook for actual earnings growth?"

While the attacks prompted many Wall Street analysts to reduce profit estimates and price targets they had previously lowered because of the slowing economy, Mecray and other defense analysts have increased forecasts even as some shares have gained 40 percent.

Last week, Morgan Stanley Dean Witter & Co. analyst Heidi Wood increased Raytheon Co to "outperform" from "neutral" and SG Cowen analyst Cai Von Rumohr raised the stock to "buy" from "neutral." Some investors said the analysts have little choice.

"If I am a defense analyst, and I miss this cycle when the stars are lined up as well as they are now, I would be embarrassed," said Scott Kuensell, who helps manage US$7 billion at Brandywine Asset Management, which owns shares of Northrop and Raytheon, the No. 3 defense company.

Mecray raised Northrop to "buy" from "market perform" on Sept. 4. The Los Angeles-based company, whose military products also include Navy ships, trades at 8.7 times next year's projected earnings before interest, taxes, depreciation, amortization and pension obligations, Mecray said.

That's lower than Lockheed Martin Corp, at more than 10 times, and Raytheon, which trades for more than nine times projected profits, he said.

Northrop's earnings would grow even without the attack-related increase in military spending, Mecray said, as the company starts production in its airborne radar and electronic-warfare programs.

Mecray expects Northrop to earn US$6.35 a share this year and US$7.40 in 2002. Wall Street analysts project profits of US$5.84 this year and US$6.17 next year, according to Thomson Financial/First Call.

While Northrop and others will gain from a military buildup, some investors said the shares have become too expensive. Among the 14 analysts that follow Northrop, nine recommend buying the shares and five rate the stock "hold."

"The US will beef up the military more than they expect, and everyone will benefit, but to what extent?" said Adam Friedman, co-manager of US$700 million Armada Large Cap Value fund, which owns General Dynamics Corp and Northrop shares.

"Is it worth 35 percent more" in stock prices? he said.

"I am not sure."

Friedman sold shares of Alliant Techsystems Inc. on Sept. 17 after the maker of munitions jumped 20 percent in the first day of trading following the attacks.

Northrop, Raytheon, General Dynamics and Lockheed Martin Corp. have had four of the nine biggest gains in the Standard & Poor's 500 Index since trading resumed.

Northrop fell US$1.97 to US$101 on Friday, Raytheon lost US$0.05 to US$34.75, General Dynamics declined US$1.28 to US$88.32 and Lockheed Martin rose US$0.45 to US$43.75.

Not all of the stocks Mecray follows have gained. In addition to defense companies, the 31-year old analyst tracks planemaker Boeing Co and jet-engine manufacturer United Technologies Corp.

Boeing has slumped 23 percent and United Technologies has lost 30 percent since the attacks.

"I am an aerospace and defense analyst," he said, "so I have had the worst and the best of it. There has been a lot of interest in the group with those who lost money on the aerospace side and those who made money on the defense side."
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