We currently remain on the sidelines with Lockheed Martin Corporation (LMT) due to the impact of the Euro-crisis on U.S. economic fundamentals. This keeps the risk high for further cutbacks in defense budgets. However, we believe market pessimism is fully accounted for in the current valuation of the defense behemoth, which is priced at a discount to both industry peers and the overall market.
Lockheed Martin is the largest U.S. defense contractor with a platform-centric focus that guarantees a steady inflow of follow-on orders from a leveraged presence in the Army, Air Force, Navy and IT programs. We expect the company to benefit from a strong defense focus on a number of its platform programs, such as the C-130 Hercules & C-5 Galaxy transport aircrafts, F-16 Fighting Falcon multi-role jet, MH-60 Helicopters, the Advanced Extremely High Frequency & the Global Positioning Satellite III system satellites, the Littoral Combat Ship, and the Aegis Weapons System.
Going forward, we believe Lockheed Martin has significant upside potential based on the Obama administration’s focus on Intelligence Surveillance Reconnaissance (ISR), unmanned systems, force protection, cyber-security, and missile defense. It already sits on an order backlog of approximately $80.7 billion at the end of the fourth quarter of 2011.
Lockheed Martin has one of the strongest balance sheets among its peers with a stable long-term debt-to-capitalization of 67.7% after the end of the fourth quarter of 2011. Lockheed continues to be a strong cash generator with its operating cash flow reaching approximately $4.3 billion during fiscal 2011.
Management is also generous in returning a substantial portion of its free cash flow to shareholders through share repurchases and incremental dividends. The company closed fiscal 2011 with cash and cash equivalents of $3.6 billion, short-term investments of $3 million and a $1.5 billion revolving credit facility expiring in August 2016. Total long-term debt of approximately $6.5 billion was mainly in the form of fixed interest bearing securities (notes and debentures).
On the flip side we must remember that a large percentage of Lockheed Martin’s business comes from the US government (82% of sales in 2011). Budget deficits and political uncertainty make future defense budgets vulnerable to cutbacks.
Going forward, Pentagon is seeking to trim about $487 billion in defense spending over 10 years to meet deficit reduction targets. Also, U.S. economic fundamentals are basically being kept on a leash as the Euro-crisis continues to cast its spell over financial markets, risking further cutbacks in future defense budgets.
Per the Bureau of Economic Analysis, in December 2011, personal income rose 0.5%, disposable personal income rose 0.4% and personal consumption expenditures fell 0.1%. Our apprehension is fueled by $15 trillion of national debt and an unemployment rate hovering around 8.3% which would lead to the Budget Control Act’s dictum of automatic cutbacks across the board going forward. This would result in nothing extra for defense goliaths in general and Lockheed Martin in particular.
Lockheed Martin, is also worried about the future of the F-35 Joint Strike Fighter. The F-35 is the Pentagon s biggest weapons program, at an estimated cost of $382 billion, for development and purchase of planes. The downsized defense budget aims to wriggle out most of the savings from the program.
The budget proposal for fiscal 2013 suggests a deduction of $1.6 billion from the F-35 program by eliminating 13 planned aircrafts. The budget proposal provides $9.17 billion for 29 F-35 aircrafts, two less than what was sanctioned for fiscal 2012. There are also proposals to delay the procurement plan under the F-35 program, reducing its planned purchase order from 423 to 244 during the period between fiscals 2013 to 2017.
The U.S. Defense Department estimates that this would bring in a total of $15.1 billion in savings. Any more snips at the F-35 program would greatly affect the fortunes of the world’s largest stand-alone defense company. The scissors are at work on Lockheed’s Thaad missile interceptor program as well, which at a conservative estimate would bring in $1.8 billion in savings through 2017.
Given the budgetary cuts and overall scenario, it would not be too pessimistic to advise investors to adopt a wait-n-watch approach for the defense and aerospace goliath. This justifies the Zacks #3 Rank, which translates into a short-term Hold recommendation. Considering the company’s business model and fundamentals, we maintain our long-term “Neutral” recommendation on the stock. This is in sync with its peers like The Boeing Company (BA) and Northrop Grumman Corporation (NOC).
Over the longer run, we expect the company to register a stable performance given its diversified presence in a plethora of defense platforms and IT know-how. Also, shareholder return will continue to be shored up by the company’s focus on debt repayment, its ongoing share repurchase program and the incremental dividend.
BOEING CO (BA): Free Stock Analysis Report
LOCKHEED MARTIN (LMT): Free Stock Analysis Report
NORTHROP GRUMMN (NOC): Free Stock Analysis Report
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