Trouble for Lockheed Martin Corporation’s (LMT) largest program, F-35 Joint Strike Fighter, is mounting. Pentagon recently stated that the projected cost of developing and building the F-35 Joint Strike Fighter rose 4.3% year over year to $395.7 billion in fiscal 2011. Pentagon now estimates that the total lifetime cost of the new warplane, taking into account production, operating and maintenance costs, and inflation, will reach $1.45 trillion over the next 50-plus years. Facing steep rise in costs, Pentagon is planning to postpone procurement orders for 179 planes for five years, a move which would save $15.1 billion through 2017.
The upside in costs was partially due to lower production demand from both domestic and international customers. Facing lower orders, Pentagon's acting chief weapons buyer, Frank Kendall, postponed full-rate production of the fighter by two years to 2019.
At an estimated cost of $382 billion, the F-35 is the biggest weapons program at Pentagon for the development and purchase of planes. Any cuts in the F-35 program would affect the fortunes of not only Lockheed Martin, but also the engine supplier of the fighter, United Technologies Corporation (UTX).
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.
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.
In the long term, 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.
However, we believe market pessimism is fully accounted for in the current valuation of the company, which is priced at a discount to both industry peers and the overall market. In view of these factors, we currently remain on the sidelines on Lockheed Martin. 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 have a long-term “Neutral” recommendation on the stock. This is in sync with its peers like The Boeing Company (BA) and Northrop Grumman Corporation (NOC).
BOEING CO (BA): Free Stock Analysis Report
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UTD TECHS CORP (UTX): Free Stock Analysis Report
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