Lockheed Martin Corp. (LMT): 3.20% Dividend Yield and Strong Customer Wins Make Shares Attractive for the Long Run
When we last recommended Lockheed Martin, in late October 2013, shares were at $129. Now, merely seven months later, shares are at $167.17 (as of June 6, 2014), up 30%, but still have significant upside. Since our last report, Lockheed appears better positioned than before to win the race on land and in space.
FastGraphs predicts shares could rise to $243 by year-end 2019 for a 10.2% total annualized return. Lockheed currently offers a dividend of $5.32 annualized for a dividend yield of 3.18%.
Shares trade at a P/E of 17.4x which is lower than 61% of its peers in the aerospace and defense sector. Lockheed’s operating margin is in the 75th percentile of its peers but the company carries higher debt levels than its industry average.
However, the recent run-up in shares has many analysts issuing a Hold rating on temporary valuation concerns as shares now trade close to their average 12-month target price of $170.
Recent and Expected Wins Signal Market Leadership across Multiple Sectors
After an 18-month review, Canada appears to be leaning towards purchasing 65 Lockheed Martin F-35 joint strike fighter jets for $8.2 billion, with support from the Canadian prime minister’s office and an independent four-member panel. An announcement is expected within the month of June 2014. While Lockheed had earlier come under fire for cost overruns on the F-35, customers now appreciate the 9% reduction in jet operating expenses. Internationally, the F-35 is well-positioned for more orders, and growing production should reduce production and procurement costs while improving margins.
In June 2014, Lockheed won three contracts from the U.S. Department of Defense (DoD) – totaling $606 million – $452 million for space reentry vehicles and support, $134 million for ballistic missile testing support and $20 million for sustaining engineering services.
Lockheed recently won a $915 million contract for a radar-system that tracks “space junk” created over 50 years of space missions, beating out rival Raytheon Co. (RTN). Space junk includes over 200,000 objects orbiting the earth at 17,500 miles per hour that pose serious collision risks to the International Space Station and other vital space installations including satellites used for weather, global communications, navigation and Internet applications.
In May 2014, Lockheed acquired the Space Operations business of Astrotech Corp. (ASTC) for $61 million. The acquired business is a leader in satellite launch preparation services and complements Lockheed’s satellite and space systems.
In May 2014, Lockheed won a $69 million contract for its C4ISR intelligence, surveillance and reconnaissance systems for real-time situational awareness and to boost maritime security for the U.S. Coast Guard.
Record Orders Backlog
While the U.S. government’s defense budget is under pressure, Lockheed expects revenues to shrink a little near-term but sees this as a natural spending cycle. The U.S. government’s sequestration cuts – a $1.1 trillion reduction over eight years – went into effect in March 2013 Even so, many of Lockheed’s programs have been approved and funded, and the company now sits on a record orders backlog that provides revenue resilience going forward.
In addition, Lockheed has won a string of new competitive bid contracts against its competitors, which underscores the company’s strength in innovation, production, delivery and services.
In the first week of June, Lockheed delivered the first F-16 aircraft to Iraq’s Air Force as part of a 36 aircraft order under a U.S. DoD contract which includes mission equipment and support. Iraq is the 27th nation to incorporate the F-16 fighter jet into its air defense fleet. Lockheed has delivered 4,540 F-16s to-date, and production is currently scheduled through 2017, with many customers requesting major upgrades to their existing fleets.
Strong Product Portfolio, Strong International Demand
In response to tightening domestic budgets, Lockheed has stepped up its international sales’ initiatives and expects international revenue contribution to exceed 20%.
With crises in Ukraine, the South China Sea, North Korea and other parts of the world, international demand for Lockheed’s products is rapidly growing on multiple fronts. Its F-16 fighter jet is still in strong demand with backorders through 2017 production. Its newer F-35 strategic strike fighter jet has been well received and global orders are on the rise. In addition, Lockheed sees continued strong demand for its C-130J transport aircraft, air and land-based missile defense systems, command and control systems, cybersecurity products and services, unmanned vehicle programs and more – all aimed at tightening national security in an uncertain world.
Germany is nearing a decision on a $3.5billion purchase of a missile defense system, on which Lockheed is a front-runner. In addition, Poland is looking at acquiring a $5 billion missile defense system for its “Polish Shield” project for national security.
Also, while defense will continue to be strong, Lockheed has been an early pioneer in cybersecurity simply because protecting sensitive information comes with the territory of defense and intelligence. Lockheed’s strong focus on corporate and governmental cybersecurity offers significant growth upside. In June 2014, Lockheed marked the 10th anniversary of its cyber-defense security program – one of the world’s most sophisticated cyber security programs – and discussed ways to protect business and government networks from growing cyber-threats amid growing demand for Lockheed’s cyber services and products.
Lockheed is also well positioned to capitalize on increasing demand for unmanned vehicles – an area where Lockheed has been active through unmanned underwater vehicles for oil and gas operations (for rig checks), unmanned vehicles for defense such as squad mission support in the war theater, forward ops carriers, unmanned supply helicopters, and unmanned planes such as the FURY and the STALKER.
Seasoned Veterans on Management Team
Led by CEO Marillyn Hewson, a 30-year Lockheed veteran, the company’s senior management has an average tenure of at least 25 years with Lockheed or the defense contracting industry. While budget cycles will come and go, Lockheed management is squarely focused on execution that drives profits and cash flow, on new business development, on technology leadership and what Lockheed calls “innovation with purpose” focused on evolving and developing the company’s product-line for the future.
Strong Cash Flow, Strong Track Record of Dividend Increases and Buybacks
Lockheed’s is a cash-rich business, and management has a stated goal of returning 50% of its annual free cash flow to shareholders, either through dividends or buybacks each year. Since 2003, Lockheed has returned over $28 billion to shareholders and has increased dividends for each of the past 11 years.
In 2013, Lockheed discontinued employee stock options, which, in the past, increased share dilution. With no stock options, Lockheed should be able to more aggressively decrease its float and increase earnings per share.
In Q1 2014, Lockheed bought back 7 million shares for $1.1 billion, 37% more than in the year-ago quarter despite a significantly higher average share price. As a result, share count was down 31% from its 2002 peak. The company paid cash dividends of $444 million, up from $371 million in Q1 2013 – consistent with management’s desire to consistently raise dividends.
F-35 Program On-Track; As Production Ramps Up, Margins Should Improve
Lockheed has seen solid demand for its F-35 fighter jet. As orders ramp-up, profit margins should benefit from scale effects from full production.
In response to cutbacks in U.S. defense and space spending, Lockheed reduced its headcount significantly over the past few years, shut down certain facilities and consolidated production, and reduced overhead so margins would not be overly impacted.
However, Lockheed management understands the cyclicality of order flow (through 30+ years of being in the industry) and has not cut back on capital investments to support innovation and growth in key areas that will drive future revenue.
Q1 2014 Results – Revenue Dips But Earnings Still Rise 23% on Strong Margins
For its first quarter ended March 30, 2014, Lockheed reported a 4% dip in net sales to $10.7 billion which was in-line with expectations based on U.S. budget cuts and sequestration. However, Lockheed’s focus on high margin businesses and tight cost controls helped expand segment operating margin to 13.4% and increase
earnings by 23% to $933 million ($2.87 per diluted share). Lockheed generated $2.1 billion in operating cash flow.
Q1 earnings were received a $53 million boost from pension income that added $0.16 per diluted share, less than the $75 million boost in the year-ago quarter.
Segment-Wise Results – Revenues Down but Margins, Profits Up
With sequestration in effect, net sales only grew in the Aeronautics division and were down in the other four operating segments. However, tight cost controls and a focus on higher-margin projects resulted in higher year-over-year operating profits at every division except IS & GS. Operating margins were higher in all segments except Aeronautics, which saw margins decline from 11.9% (Q1 2013) to 11.6%.
Improved FY 2014 Outlook
For FY 2014, Lockheed increased its outlook on operating profit, diluted EPS and operating cash.
At quarter end, Lockheed had $3.3 billion in cash and cash equivalents, $36.9 billion in total assets and $6.2 billion in total debt (unchanged since the end of 2013). Shareholders’ equity dipped to $4.8 billion from $4.92 billion at year end 2013.
Lockheed shares have risen sharply over the past year and could see some profit-taking, especially given the average HOLD recommendation on Wall Street. That said, shares trade at a slight P/E discount to the industry average and should rise long-term based on strong underlying fundamentals. Lockheed has consistently been winning new contracts by beating out key competitors, and expects revenue growth from international expansion and key programs such as the F-35, air transport, missile defense, space and cyber security. Long-term shares are a BUY and dips should be seen as buying opportunities. Option traders could also benefit from near-term share price uncertainty while locking in future growth.