JMorgan shuffles defense ratings, names L-3 top pick, cuts Northrop
JPMorgan named L-3 Communications (LLL) as its new top pick in the defense sector, and recommended taking profits on another name in the sector, Northrop Grumman (NOC). The firm upgraded L-3 to Overweight and downgraded Northrop Grumman to Neutral in a new sector note issued this morning. L-3 APPEALING: JPMorgan analyst Seth Seifman upgraded L-3 to Overweight from Neutral, noting that he expects the company to generate 5% compound annual free cash flow growth through 2020, the second highest level among the defense stocks he covers. However, the company is trading at the second lowest free cash flow multiple among the defense stocks he covers, the analyst reported. The company should generate 2% annual organic growth, and at least one percentage point of margin expansion through 2018, while "pension is a cash tailwind" for it through the end of this decade, wrote Seifman, who raised his price target on the shares to $182 from $158. NORTHROP DOWNGRADED: Northrop Grumman's 2017 free cash flow yield will be "in line with the market and below many industrials," according to Seifman, who downgraded the stock to Neutral from Overweight. Moreover, Northrop's cash return yield is no longer exceptional, and it has a low dividend yield, Seifman believes. Finally, although the company's organic growth should accelerate to 5%-6%, the acceleration is already baked into the stock, which has a high valuation, the analyst believes. He raised his price target on the shares to $231 from $225. WHAT'S NOTABLE: Seifman remained generally upbeat on the defense sector, predicting that the average defense stock would rise by at least 10% over the next 16 months. Investors should continue to be attracted by the companies' "robust, visible cash flows and...commitment to returning that cash," stated the analyst, who kept Overweight ratings on Harris (HRS) and Raytheon (RTN). PRICE ACTION: In late morning trading, L-3 advanced 1.7% to $149.23 and Northrop Grumman added 0.4% to about $214 per share.