Many people now warns about the political situation in the world. Civil War in Ukraine, attack on Paris, ISIS war with western countries- all of these create a huge amount of fear into the hearts of people about the prosperity of the future. No one feels safe in our days, especially this feeling of insecurity concerns investors. Investors usually don't like uncertainty. Therefore, many investors now think how to save money. It can be useful, because there is space for big war in the future as Western allies worsened relationship with Russia. There is investment, that can hedge investors at the time of political instability. Investor should look precisely on the Aerospace/Defend companies. These companies will prosper in the time of instability. War will benefit them and their investors. One of the companies of this sector is Northrop Grumman. Northrop Grumman Corp (NYSE:NOC) is a security company that provides systems, products and solutions in unmanned systems, cybersecurity; command, control, communications and computers (C4) intelligence, surveillance, and reconnaissance (C4ISR); and logistics and modernization to government and commercial customers. Northrop Grumman is very old and big (market cap 35 billion $) company, which was originally in California in 1939 and was reincorporated in Delaware in 1985. Members of Aerospace/Defend sector are particularly sensitive to the success or failure of programs that they serve. But, if the company is very large, their contract mix is very large and complicated, which defend them from the huge drop in net income, if particular contract will fall. So Northrop Grumman size creates a hedge against such risks. The company conducts its business with the U.S. Government, principally the Department of Defense (DoD), company also conducts business with foreign governments and domestic and international commercial customers. Now Company has four sectors: Aerospace Systems, Electronic Systems, Information Systems and Technical Services. However, in the October 2015, the company announced that they reduce the number of sectors from four to three. Two new sectors will be created by merging elements of current Electronic Systems, Information Systems and Technical Services sectors. A new Mission Systems sector will be composed of existing Electronic Systems sector and the businesses from current Information Systems sector focused on the development of new capabilities for military and intelligence customers. The services portfolio in the Information Systems sector will combine with the Technical Services sector to form the new Technology Services sector. These changes will not affect our analysis, as they will be implemented in the 2016. However, we should refer, that we think that dynamic changes in the company is the good sign, as company develop with the time. Such changes can potentially increase the value of the company. Knowing the structure of the firm, we should look at its financial.First of all, which will be noticed by investors, when they analyze companies 10-Q fillings, is that company experience sales decline. It declined from around 28 billion dollars at the end of 2010 to the 24 billion dollars in the 2014. Therefore, investor should anticipate declines in the net income and EPS respectively. However, it is not happened. Their net income for the December 31 2014 is 2,069 million vs. 2,053 million in the 2010. All this cannot convince to buy company shares, but there is one amazing statistic: EPS increased from 6,32$ to 10,38$ for the last 5 years. It means that EPS CAGR for the last 5 years is 13,3%. How it can happen if their sales fell? There are two factors: 1) Repurchase program. In recent years, the government has been unwilling to permit the defense industry to make large acquisitions in their field. As a result, the excess "Cash Flow" developed by many of defense companies has tended to build up. Dividends have increased, debt has been paid off, and companies have spent billions of dollars to retire their common stock during the past five years. Northrop Grumman especially succeeded in this program. In just 3.5 years, the company has removed in excess of 65 million shares from the market, reducing the share count by in excess of 25%: In this year they stated that they will continue to repurchase shares and provided for this program 3 billion $. This means that managers of the company interested in creating value for investors. We think that it's a very good sign. Warren Buffet often says that he thinks that companies, which can't provide high growth in the net income, should return excess cash to shareholders. Especially it will be beneficially to them, if the company returns money in the form of repurchase program, because investors don't pay taxes in this case. Dividends surely is not tax deductible. 2) Operational Performance Managers of the company seriously deducted operational costs. This measure helped companies net income to be stable for the last 5 years. Operating Income, even increased in this year: (Source: group analysis) Operating margin increased by 3% and Net Margin increased by 1%. As these numbers are quite stable and indeed very high we think that the management of the company did a solid job of controlling expenses in this period. Northrop Grumman so created a solid base for the future growth, which we anticipate. Reason for this simple, market for weaponry has its own cycle. During a war, defense spending rises rapidly, with expenditures on procurement and research & development (the lifeblood of this industry), climbing at a fast pace, but when the war is over, and/or public perceptions of risks fade, then spending on defense stops climbing (which may result in a decline in inflation-adjusted spending) or an actual decline in current dollars. Company for the last 5 years experienced declining part of the cycle. We think that defense industry now near the low. Evidences for the growth is that military budget in the 2016 increased first time since 2010.The graphic below shows the DoD's (DoD - Department of Defense) FY2016 budget request along with their projections out to FY2020. If we will investigate relative not absolute numbers, like defense spending as a percentage of the Federal budget, we see same evidences: As you can see defense spending is pretty much at an all time low of 14.3% of the budget. With the global war on terror showing no signs of slowing down and both Democrats and Republicans agreeing on the need for increased defense spending in the future there is enough headroom in the Federal budget to accommodate increases in defense spending. Moreover, in the November26 Obama signed defense bill into law .This legislation authorizes $607B in annual defense spending and "includes vital benefits for military personnel, facilitates ongoing operations around the globe, and important reforms to the military retirement system." So, there are plenty evidences that new cycle begins. Which products can supply Northrop Grumman in the upcoming cycle? Northrop's portfolio includes: The U.S. Air Force (USAF) RQ-4 Contract Sales will increase from 1,0747 million dollars to 1,420.3 million dollars Missions: The USAF and NATO AGS RQ-4 systems perform high-altitude, near-real-time, high resolution ISR collection, while the Navy MQ-4C provides persistent maritime ISR. Both AF and Navy systems support Joint and Combatant Commander requirements, while the Navy MQ-4C also supports the numbered Fleet commanders from five worldwide sites. FY 2016 Programs: RQ-4 Global Hawk: Funds the development and modification efforts for the Block 30, Block 40, ground stations, and Multi-Platform Radar Technology Insertion programs; and the U.S. contribution to the NATO AGS. MQ-4C Triton: Continues Engineering and Manufacturing Development efforts; and, procures three Low Rate Initial Production systems. The AH-64E Apache Contract Sales will increase from 959.4 million dollars to 1,448.3 million dollars Mission: Conducts armed reconnaissance, close combat, mobile strike, and vertical maneuver missions in day, night, obscured battlefield, and adverse weather conditions. FY 2016 Program: Funds the remanufacture of 64 AH-64D aircraft to the AH-64E configuration and continued development of upgrades to enhance operational capabilities. The E-2D Advanced Hawkeye Contract Sales will increase from 1,313.05 million dollars to 1,315 million dollars Mission: Provides theater air and missile sensing and early warning; battlefield management command and control; acquisition tracking and targeting of surface warfare contacts; surveillance of littoral area objectives and target; and tracking of strike warfare assets. FY 2016 Program: Funds five E-2D aircraft in the third year of a Multi year Procurement contract, associated support, and funds advance procurement for future aircraft. You can see that company will increase sales in the upcoming year. But these contracts is not game changers. However, Northrop Grumman has such contract. Northrop Grumman's contract to build a new fleet of long-range bombers for the U.S. Air Force, Forbes reports: "A modernized and capable Air Force bomber force of 150 to 200 aircraft is required to maintain America’s asymmetric advantage in long-range precision strike over any potential future adversary," states a study published by the Mitchell Institute for Aerospace Studies. Last month the Pentagon awarded Northrop the first portion of a planned $100B contract to develop and build 80-100 new stealth bombers. It happens, because company before created such bomber. It is the famous B-2 Spirit, also known as the Stealth Bomber. B-2 is built for stealth. During the Cold War, it was designed to beat air defense systems, penetrating deep into Soviet Union airspace and deliver a nuclear bomb if necessary. Its design allows it to evade radar and makes it tough to detect. Instead of metal, the structure is made from advanced composites like resin-impregnated graphite fiber. So, we see how Northrop Grumman have a game-changer contract, and company will rise revenue in the future, now we should value company itself. We assumed increase in the sales due to the increasing size of the governmental contracts, and using this assumption we calculated predicted Income Statement for Northrop Grumman in the next 5 years. Also, we used DCF method, and used in this process two types of it: earning based and Free Cash Flow based. All three methods gave positive margin of safety. However, we assumed that P/E ration will be around median number, but at the time of political instability investors can easily increase it to the 30x or more values. But in this time, we think that gain will be speculative. (Source: group analysis) Also, we used DCF method. Particularly, we used in this process two types of it: earning based and Free Cash Flow based. All three methods gave positive margin of safety. However, we assumed that P/E ration will be around median number, but at the time of political instability investors can easily increase it to the 30x or more values. But in this time, we think that gain will be speculative. Northrop Grumman financial ratios ,in comparing with industry competitors , given there: (Source: group analysis) You can notice unusually high ROIC and low WACC, which suggest that companies in this sector highly effectively return cash from their investments. Also, ROE of the company is very high, around 29%, which show highly effective usage of assets of the company. We think that Northrop Grumman can increase its leverage to the level of Lockheed Martin and obtain much higher ROE (around 70%). This another space for the future growth of the company. PEG of the company shows indeed that company is overvalued, however PEG can underestimate cyclical companies, as its use for the calculation past 5 year growth percentage. It means that PEG ratio can't be so useful, when cycle begin. Conclusion Beginning the military budget cycle, political instability in the world, solid financial results during the last 5 years, new contract on long-range bomber and good management of the company - all of these factors in combination with positive Margin of Safety( at least 10%) make Northrop Grumman excellent choice for investors, who want hedge themselves from the future shocks. Our Recommendation: BUY