This is not the time to be loading up on defense stocks. The department of defense's fiscal year 2012 budget request will be submitted in February and the discussions leading up to it will pressure the defense stocks. Also, given a shrinking backlog for many of the companies within the sector, I believe that consensus estimates remain meaningfully too high and will be revised downward throughout the 2nd half of 2010, particularly if current pension assumptions (i.e., interest rates and asset returns) hold.

Northrop Grumman Corp. (NOC) on July 28th, Northrop reported adjusted 2nd quarter EPS ahead of consensus, and revised guidance higher --- highlighting improved margin performance. However, cash flow was weak and Northrop joined the list of defense companies to report declining backlog and weak bookings. Here are my concerns regarding Northrop and why it is a stock to sell: 1) the company is way too leveraged to the defense sector view where I expect pressure on Department of Defense spending and contractor margins. Northrop also joined the list of defense companies reporting weak book-to-bill on the back of another sequential decline in backlog. 2) While Northrop showed some margin improvement in the 2nd quarter --- outside of ships --- its margins and returns on capital remain the lowest in its peer group. 3) If interest rates and asset returns simply stay where they are today, 2011 and 2012 estimates could be reduced down by 11% (of current EPS) or even more.

Yesterday I speculated that McCain picked Sarah Palin as his VP over the objections of his advisers. I thought that McCain -- who prides himself on fighting corruption in politics -- somehow saw himself in her. But both politicians have experience with the very thing they pride themselves on fighting.

In the case of McCain, his efforts to rid politics of the corrupting influence of corporate money followed his protection of Charles Keating who was securing a real estate deal for his wife, Cindy. The bankruptcy of Keating's S&L cost taxpayers $3.4 billion. More recently former McCain Finance Chair Tom Loeffler, a lobbyist for French company EADS, parent of Airbus, helped it and Northrop Grumman (NYSE: NOC) to prevail in a $35 billion competition for airborne refueling Tankers in February over Boeing Inc. (NYSE: BA) before the General Accounting Office (GAO) concluded that the process was flawed.

Alaska's governor, Sarah Palin, knows a thing or two about lobbyists. The New York Times reveals that she won that post after taking on bribery charges from the oil industry against politicians -- her attack against such corrupting influences helped her prevail over former Alaska governor, Frank Murkowski. That's why it came as a surprise to learn that as governor Palin employed a lobbyist for an energy company for which she procured $500 million in state subsidies so it could build a gas pipeline.

Boeing Co. (NYSE: BA) gets a mixed report card this morning. Its earnings were up 38% in the first quarter but it lost a $3.74 billion deal to Northrop Grumman (NYSE: NOC). The Wall Street Journal [subscription required] reports that Boeing earned $1.62 in the first quarter, beating analysts' estimates by 27 cents a share. But Bloomberg News reports that Boeing lost another contest with Northrop -- this time for a spy plane, specifically a drone.

First, the good news for Boeing. The Journal reports that its net income of $1.21 billion, or $1.62 a share, increased 43% from $877 million, or $1.13 a share, a year earlier, while its revenue climbed 4.1% to $15.99 billion. Also important, Boeing reiterated its boosted guidance for earnings of $5.70 to $5.85 a share on $67 billion to $68 billion in revenue. Analysts' latest mean estimates were $5.93 and $68.95 billion, respectively. Even better, it raised its earnings projections for 2009 to between $6.80 and $7 a share on strong production-program performance and declining research-and-development and pension expenses. Analysts were expecting $6.87.

Now, the bad news. Northrop's Global Hawk drone beat Boeing's aircraft for the 68 plane order, after in February, Boeing already lost an Air Force competition for refueling tankers. Northrop, which had never built a refueling aircraft, faced a Boeing team that supplied the Air Force for more than half a century. Northrop won that $35 billion program by offering a larger jet with more fuel capacity than Boeing. Is Boeing's lack of competitive vigor on the defense side a sign of deeper management problems?

Investors don't seem concerned. Boeing stock is up over 2% in early trading.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He is writing a book about Boeing and has no financial interest in the securities mentioned.

MOST NOTEWORTHY: Dendreon Corp (DNDN), Cubic Corp (CUB), Endo Pharmaceuticals (ENDO), Northrop Grumman (NOC) and Royal Dutch Shell (RDS.A) were today's notable downgrades:

• JMP Securities downgraded shares of Dendreon Corp (NASDAQ: DNDN) to Market Underperform from Market Perform based on the company's uncertain product pipeline and the recent SEC filing that revealed that certain officers and directors are facing potential shareholder lawsuits regarding trading activities.
  

• Friedman Billings cut Cubic Corp (AMEX: CUB) to Underperform from Market Perform on valuation.

• RBC Capital downgraded Endo Pharmaceuticals (OTCBB: ENDP) to Sector Perform from Outperform following the company's withdrawal of guidance pertaining to its NDA for the Ketoprofen patch.

• Northrop Grumman (NYSE: NOC) was cut to Neutral from Overweight at JP Morgan on valuation. UBS cut Royal Dutch Shell to Neutral from Buy on valuation...

OTHER DOWNGRADES:

• Robinson Humphries downgraded Ruby Tuesday (NYSE: RT) to Neutral from Buy.

• Montgomery downgraded shares of Taleo Corp (NASDAQ: TLEO) to Hold from Buy.

• Credit Suisse downgraded AutoZone (NYSE: AZO) to Neutral from Outperform.

Analyst summaries provided by TheFlyOnTheWall.com (subscription required).

In yet another bout in the Boeing Co.(NYSE: BA)-Airbus slugfest, both are involved in bids to supply the U.S. Air Force with 12-18 refueling tanker planes annually. The contract value is estimated at $40 billion.

Airbus (EADS) is partnering with Northrop Grumman Corp. (NYSE: NOC) to offer the Northrop-Grumman KC-30, a version of EADS' A330. To counter the protests already being voiced by American workers about defense jobs being lost overseas, EADS would assemble the planes at Northrop's facility in Mobile, Alabama. EADS estimates 52% of the work would be done on U.S. soil, providing 25,000 jobs.

Boeing's proposal will offer the tanker version of its 767, the KC-767, which it claims will be 85% American-made and provide up to 44,000 jobs. The plane is already being used by the Italian Air Force and Japanese Air Self-defense Force.

The Air Force is expected to announce the winner of this competition by the end of the year.

MOST NOTEWORTHY: EMC Corp (EMC), Network Appliance, Inc (NTAP), ImClone Systems Inc (IMCL) and International Game Technology (IGT) were some of today's more notable upgrades:

• JP Morgan upgraded EMC Corp (NYSE: EMC) to Overweight from Neutral as the firm believes improved momentum in the second-half of 2007 will drive shares higher.

• Network Appliance (NASDAQ: NTAP) was also upgraded by JP Morgan, to Overweight from Neutral, as the firm believes storage will experience improving secular trends this year.

• Citigroup upgraded ImClone (NASDAQ: IMCL) to Hold from Sell and raised their target to $40 from $26 due to lower competitive threats from Amgen Inc's (AMGN) Vectibix.

• Prudential raised International Game Technology's (NYSE: IGT) rating to Neutral from Underweight, citing valuation.

OTHER UPGRADES:

• Goldman Sachs upgraded DreamWorks Animation SKG, Inc (NYSE: : DWA) to Buy from Neutral with a $36 target and added DWA to their Americas Investment Buy List. Goldman believes the company's new films should drive a higher valuation.

• Wachovia upgraded Urban Outfitters, Inc (NASDAQ: URBN) to Outperform from Market Perform after a meeting with management as they believe a turnaround is well in progress.

• Wachovia upgraded Northrop Grumman Corp (NYSE: NOC) to Market Perform from Underperform on valuation.

• AG Edwards upgraded Western Union Co (NYSE: WU) to Buy from Hold with a $36 target.

• Friedman, Billings, Ramsey upgraded shares of Progressive Corp (NYSE: PGR) to Market Perform from Underperform on valuation.

Analyst summaries provided by TheFlyOnTheWall.com (subscription required).

Lockheed Martin Corp. (NYSE:LMT) and Northrop Grumman Corp. (NYSE:NOC) today posted solid fourth quarter results today, helped by the huge increases in defense spending from the War in Iraq and Afghanistan. Both companies also raised their earnings guidance.

Lockheed's profit was $729 million, or $1.68 per share, versus $568 million, or $1.29 a year earlier, the Bethesda, Maryland-based company said in its earnings release. Sales rose 6 percent to $10.84 billion. Analysts had been expecting profit of $1.46 and sales of $10.77 billion, Thomson Financial said.

The company raised its profit forecast for the year to $5.80 to $6 per share, from its previous guidance in October to reflect improved performance in its aeronautics business. Revenue is seen at $40.25 billion to $41.25 billion. Analysts had expected profit of $5.87 on revenue of $41.6 billion.

``We've had very consistent program performance and execution,'' Lockheed CFO Christopher Kubasik told Bloomberg News. ``One thing we're striving for is perfect execution on all 3,000 of our programs. When you meet your deadlines and deliver products and services on time and on budget, you see the contribution to the bottom line.''

Northrop's profit rose to $453 million, or $1.28 per share, compared with $331 million, or 92 cents, the Los Angeles-based company said. Revenue jumped to $8.02 billion from $7.67 billion. Profit from continuing operations was $1.29, beating Wall Street expectations for profit of $1.26, according to Thomson Financial.

The company's guidance for 2007 was $4.80 to $5.05 per share on sales of $31 billion to $32 billion. Analysts had expected profit of $4.85 on sales of $31.8 billion.