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Lockheed Martin's irrational share price surge (~$35 increase on October 18 from the prior day's ~$397 closing share price) should make investors question whether this is due to irrational exuberance or due to a significant improvement in underlying fundamentals.
I last reviewed Lockheed Martin (LMT) on July 19, 2022 at which time it had just released Q2 2022 results. Despite a ~$90 share price pullback from the ~$480 52-week high, I concluded that I would patiently wait before adding to my exposure. My rationale was that I expected LMT's share price to get swept up in any market downdraft I envisioned would occur within the next several months.
Given that irrational exuberance likely contributes significantly to the most recent share price surge, I thought it would be prudent to look at LMT despite my very limited free time resulting from the recent purchase of a second home.
Financials
Q3 and YTD2022 Results
LMT's Q3 and YTD2022 results and FY2022 guidance are reflected in material released on October 18.
Source: LMT Q3 2022 Earnings Presentation - October 18, 2022
Source: LMT Q3 2022 Earnings Presentation - October 18, 2022
On the earnings call, management indicates that LMT's backlog grew by ~$5B to ~$140B. While LMT remains on track to achieve the FY2022 outlook provided in the prior quarter, the residual pandemic impacts and supply chain challenges continue. As a result, expectations are for a return to growth in 2024 with 2023 sales being approximately equal to the 2022 outlook.
Despite challenges, LMT expects to deliver solid growth and free cash flow (FCF) per share in 2023 and thereafter through a combination of:
- cost reductions throughout the business;
- improved working capital management; and
- an expanded share purchase program.
On a reported basis, EPS was higher by $4.50 ($6.71 vs $2.21) relative to Q3 2021. Adjusting for FY2021's pension risk transfer transaction and mark-to-market accounting, EPS grew 4%. This increase primarily reflects the benefits of higher operating profit and a lower share count.
R&D and CAPEX
LMT is committed to driving long-term growth through strong independent research and development (R&D) and capital expenditure (CAPEX) funding with an expected total of ~$4B in 2023. These investments will support LMT's customers and deliver on its 21st-century security vision to accelerate leading-edge, commercial digital technologies, and the defense of the US and its allies.
A key driver of this strategy is LMT's new One LMX transformation. This is a multi-billion-dollar, seven-year company-wide program to transform the end-to-end business processes and systems. One LMX will create a model-based enterprise with a fully integrated digital thread throughout the design, build, and sustained product lifecycle.
As part of the company's ongoing corporate stewardship approach, an internal review is being conducted to identify potential synergies between the 4 business areas (Aeronautics, Missiles and Fire Control, Rotary and Mission Systems, and Space) and further cost reduction opportunities. The review also includes a general portfolio review with the goal of increasing operating efficiency in anticipation of future growth.
Free Cash Flow (FCF)
Earnings per Share (EPS) can easily be manipulated. I, therefore, look at the extent to which a company generates FCF.
In Q3, LMT's cash from operations was $3.133B and CAPEX amounted to $0.405B. YTD cash from operations is $5.874B and CAPEX is $0.977B resulting in YTD FCF of $4.897B.
Source: LMT Q3 2022 Earnings Presentation - October 18, 2022
LMT delivered its strongest quarter of cash flow YTD. Strong collections drove $2.7B in FCF in Q3. This was achieved despite maintaining accelerated payments of $1.1B ($1B in Q2) to suppliers.
Once again, cash deployed to shareholders exceeded FCF. YTD, LMT has returned ~121.4% of FCF through dividends and share repurchases.
Outlook
The following images reflect LMT's current and previous FY2022 outlooks.
Source: LMT Q3 2022 Earnings Presentation - October 18, 2022
Source: LMT Q2 2022 Earnings Presentation - July 19, 2022
With the announcement of a $14B share repurchase authorization approved by LMT's Board, the forecast for share buybacks is now ~$8B for FY2022 versus the prior $4B.
Management expects the EPS benefit from the incremental planned buybacks in 2022 to be offset by the third-quarter mark-to-market headwinds. This explains why LMT is holding its EPS guidance of $21.55 for FY2022.
Expectations are for 'flattish' sales in 2023 primarily due to delayed sales conversion as the expected recovery from COVID and supply chain shortages will be more gradual than previously expected.
In LMT's classified businesses, expectations are for another year of growth in 2023. This growth, along with LMT's contract mix headwinds, will be accompanied by pressure of ~20 - 30 bps in overall company segment operating margin. Management, however, is confident that through cost reduction and business area synergy actions, this downward pressure can be limited. Furthermore, through management focus and aggressive working capital actions, expectations are for 2023 FCF to remain unchanged in spite of the top line and margin pressure.
Credit Ratings
There is no change to LMT's senior unsecured domestic currency debt ratings subsequent to my prior review.
- Moody's: A3
- S&P Global: A-
- Fitch: A-
These ratings are the lowest tier of the upper-medium investment-grade level. They define LMT as having a STRONG capacity to meet its financial commitments. LMT is, however, somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.
Dividend and Dividend Yield
LMT repeatedly states its commitment to reward shareholders through dividend increases (see dividend history).
At the time of my January 2022 review, shares were trading at ~$380 and the $2.80 quarterly dividend yielded ~3%. When I reviewed LMT on April 19, 2022, shares were trading at ~$460; the $2.80 quarterly dividend yielded ~2.4%. When I reviewed LMT on July 19, shares were trading at ~$390 thus resulting in a dividend yield of ~2.9%. I anticipated LMT would announce in September a dividend increase to $3.00 (payable toward the end of December).
On September 30, LMT announced such a dividend increase. With shares trading at ~$432, the $3.00 quarterly dividend yields ~2.78%.
LMT generates ample Operating Cash Flow and Free Cash Flow to service its dividend.
LMT is a prolific acquirer of its issued and outstanding shares. The weighted average number of issued and outstanding shares in FY2011 - FY2021 (in millions rounded) is 340, 328, 327, 322, 315, 303, 291, 287, 284, 281, and 277. In Q1 2022 this had declined to 269.2 with a further decline to 265 at the end of Q1. The weighted average diluted shares outstanding in Q2 2022 was 266.7 but at the end of Q2, this had dropped to 264. In Q3, there was a further reduction to 265.1 and 261, respectively.
At the time of my prior review, LMT targeted ~$4B in FY2022 share repurchases. In Q1, it executed a $2B accelerated share repurchase agreement. In Q2, LMT's capital deployment included the repurchase of 9 million shares for ~$0.356B. This excluded 6 million shares received upon settlement of an accelerated share repurchase agreement (ASR) in April 2022 for no additional consideration.
In Q3, LMT repurchased another $1.338B of outstanding shares bringing the total YTD repurchases of common stock to $3.694B.
On October 17, 2022, LMT's board authorized the purchase of up to an additional $14B of LMT common stock under its share repurchase program. This multi-year share repurchase program follows the substantial completion of purchases of common stock under the prior repurchase authorization.
The company anticipates executing a $4.0B accelerated share repurchase program in Q4 2022 thereby bringing the total share repurchases for the year to ~$8B. The remainder of the repurchase program authorization is expected to be utilized over a 3-year period with funding of the repurchases coming through a combination of cash on hand and the issuance of debt.
Management now forecasts a weighted average share count of 253 million shares in FY2023. In addition, management anticipates repurchasing ~10% of shares outstanding over the next several years.
Valuation
In FY2013 - 2021, LMT's diluted PE levels were 16.02, 19.47, 19.27, 18.81, 26.04, 24.80, 18.51, 15.16, and 16.38.
I reference my July 19, 2022 post in which I look at LMT's historical valuation based on adjusted diluted EPS estimates at the time of prior LMT posts.
Now, LMT's share price has rocketed ~$34/share to ~$432 following the release of Q3 results. Management's FY2022 adjusted diluted EPS outlook, however, remains unchanged at ~$21.55. This gives us a forward-adjusted diluted PE of ~20 versus ~18.1 using LMT's October 14 ~$390 share price.
When I wrote my July 19 post, the following were the forward adjusted diluted PE levels using the adjusted earnings estimates from the two discount brokerage platforms I use.
- FY2022 - 11 brokers - mean of $22.67 and low/high of $21.75 - $26.70. Using the current share price and the mean, the forward adjusted diluted PE is ~17.2.
- FY2023 - 19 brokers - mean of $28.38 and low/high of $26.56 - $29.25. Using the current share price and the mean, the forward adjusted diluted PE is ~13.7.
- FY2024 - 13 brokers - mean of $29.19 and low/high of $28 - $30.16 Using the current share price and the mean, the forward adjusted diluted PE is ~13.4.
Using the current forward-adjusted earnings estimates from the two discount brokerage platforms I use, LMT's valuation is:
- FY2022 - 21 brokers - mean of $21.63 and low/high of $21.44 - $21.91. Using the current share price and the mean, the forward adjusted diluted PE is ~20.
- FY2023 - 21 brokers - mean of $27.48 and low/high of $25.97 - $28.66. Using the current share price and the mean, the forward adjusted diluted PE is ~15.7.
- FY2024 - 17 brokers - mean of $28.53 and low/high of $27.39 - $29.82. Using the current share price and the mean, the forward adjusted diluted PE is ~15.
In my opinion, now is not the time to acquire LMT shares. I remain convinced market conditions will deteriorate in 2023 which should lead to more favourable valuations in the coming months.
Final Thoughts
LMT was my 8th largest holding when I completed my Mid 2022 Investment Holdings Review. Although the rankings have changed subsequent to that review, I am certain LMT remains a top 20 holding.
Since the Great Financial Crisis, I have been wishing for a 'bear market'. My wish came true in September.
Life, however, does not always go according to plan. In my October 1, 2022 FFJ Portfolio – September 2022 Report I mention the purchase of a second home. Because we are not selling our existing home, I find myself in a position where I have to use the liquidity set aside to acquire attractively valued shares for the purchase of another home.
The home purchase closes on November 2. Analyzing companies, therefore, is currently not my priority. Lockheed Martin's irrational share price surge following the release of Q3 and YTD2022 results and FY2022 guidance, however, has prompted me to set aside time to caution investors.
Other than the announcement of an additional $14B of LMT common stock to be acquired under a multi-year share repurchase program, nothing suggests LMT's share price surge is warranted.
LMT is a great long-term investment. Economic weakness within the next 12 months is very possible and I do not think LMT will be sheltered. In my opinion, you would be wise to patiently wait for market conditions to deteriorate before acquiring LMT shares.
I wish you much success on your journey to financial freedom!
Note: Thanks for reading this article. Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long LMT.
Disclaimer: I do not know your circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decisions without conducting your research and due diligence. You should also consult your financial advisor about your specific situation.
I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with any company mentioned in this post.
