With tax revenue falling and entitlement spending for Social Security and Medicare on the rise, the federal government will have to make budget cuts. Most investors expect military spending to fall sharply. But some contractors remain critical to our nation’s defense. Investors can take advantage of weakness in the market to pick up shares at a discount.– The Editors

The wars in Iraq and Afghanistan are winding down as the US faces a troubling budget crisis–factors that will likely result in a decrease in defense spending. The Pentagon this year announced the first cuts in defense spending since 9/11. Furthermore, modern warfare increasingly relies on communications and technology rather than tanks and heavy bombers. It’s a worrying trend for companies that supply heavy armaments to the US Dept of Defense.

Northrop Grumman (NYSE: NOC) built the first lunar module and enjoys a storied relationship with the US defense establishment. It was one of the first defense contractors to adapt to new military realities by shifting focus from heavy weapons to the components business. By supplying the armed forces with key electronics such as radar, navigation and communications systems, the company should continue to grow revenue and thrive despite budget cuts.

The company wasn’t born as an electronics supplier. Until recently Northrop Grumman was a key naval contractor that designed, built and maintained nuclear and non-nuclear ships, including submarines and aircraft carriers. But in March Northrop spun off its shipbuilding unit, Huntington Ingalls, though the firm retained its aircraft business. As a result, Northrop’s electronics and information divisions will now contribute almost half of the firm’s revenue.

The remaining revenue will be generated by Northrop’s aerospace and technical services divisions. The aerospace division provides manned aircraft such as the B-2 Stealth Bomber and unmanned aircraft such as the Fire Scout drone, as well as missile systems and space systems. The technical services division is arguably one of Northrop’s more lucrative businesses. This division enters into long-term contracts to provide training, maintenance and logistical support, primarily to government agencies–a high margin business.

Northrop and its competitors likely will not be unscathed by deep cuts in US defense spending. But the company does enjoy several strong competitive advantages. Northrop has been a leader in providing low-cost solutions to some of the military’s most vexing problems, including turning around troubled defense research and development programs that have run over budget and past deadline. That track record of success buys a lot of leverage with the Dept of Defense.

Additionally, Northrop has more than $64 billion in backlog orders with the Pentagon, involving key projects such as the F-35 Joint Strike Fighter and various unmanned aerial systems. With annual revenue averaging around $35 billion, that backlog represents two years worth of sales already on the books, providing a nice cushion against any spending cuts.

The uncertainty surrounding future US defense spending has created an attractive opportunity to pick up Northrop shares at a discount. The company’s stock currently trades a just nine times forward earnings, 0.5 times trailing sales and only slightly over book value. This valuation is even more compelling when once considers that Northrop’s historically high growth rates are unlikely to be derailed by defense spending cuts.