Lockheed Martin Is Currently Unattractively Valued

I first reviewed LMT in this November 20, 2020 post at which time I disclosed the initiation of a 200 share position @ ~$369/share in one of the 'Core' accounts in the FFJ Portfolio. In subsequent posts (see The FFJ Archives) I disclose additional purchases which have brought my exposure to 455 shares.

In my January 25, 2022 Is Lockheed Martin Reasonably Valued? post, I conclude LMT's valuation is reasonable. Following a subsequent rapid run-up in LMT's share price and no change to management's FY2022 guidance, however, I now conclude that Lockheed Martin is currently unattractively valued.

With the release of Q1 2022 results and FY2022 Outlook on April 19, 2022, I once again revisit LMT.

Overview

LMT is probably best known for its F-35 fighter jet. A review of the 'Products' section of LMT's website, however, shows that it is a global security, innovation, and aerospace company.

Investors wishing to learn more about the company are encouraged to review Part 1 of LMT's FY2021 Form 10-K. This section provides a wealth of information about this global security and aerospace powerhouse that is principally engaged in the research, design, development, manufacture, integration and sustainment of advanced technology systems, products and services.

LMT serves both U.S. and international customers with products and services that have defense, civil and commercial applications; its principal customers are US Government agencies. Its main areas of focus are defense, space, intelligence, homeland security and information technology, including cybersecurity.

In FY2021, ~71% of LMT's ~$67B in net sales were from the U.S. Government, either as a prime contractor or as a subcontractor (including 62% from the Department of Defense (DoD)), 28% were from international customers (including foreign military sales contracted through the U.S. Government) and 1% were from U.S. commercial and other customers.

A 'Lockheed Martin' search on the DoD's website gives investors an indication of the extent of LMT's dealings with the DoD.

An April 13, 2022 News Story on 'America's Navy' website provides a further example of one of the many initiatives in which LMT is engaged.

Aerojet Rocketdyne Acquisition

In my January 25, 2022 post, I touch upon LMT's proposed acquisition of Aerojet Rocketdyne Holdings, Inc. (AJRD). Part 1, Item 1 in LMT's FY2021 Form 10-K addresses the 'Pending Acquisition of Aerojet Rocketdyne Holdings, Inc.'.

In February, the Federal Trade Commission (FTC) issued a statement regarding the termination of LMT's attempted acquisition of AJRD.

Financials

Q1 2022 Results

LMT's Q1 2022 results and FY2022 guidance are reflected in material released on April 19.

Q1 EPS of $6.44 declined by 2% and reflects the impact of lower sales volume, mark-to-market adjustments and lower FAS/CAS income, partially offset by benefits from an increase in segment operating margin, lower share count and a lower tax rate.

NOTE: The FAS/CAS pension adjustment represents the difference between pension expense under financial accounting standards 'FAS') under U.S. GAAP and U.S. Government cost accounting standards ('CAS').

On the Q1 earnings call, management indicates results were negatively impacted by:

• program life cycle transitions;
• poor winter weather conditions; and
• the Omicron variant in LMT's operations and supply chain.

Management expects the impact to be short-term in nature.

Free Cash Flow (FCF)

In Q1, LMT generated $1.142B in FCF which was ahead of expectations.

Operational cash remains solid as the business looks to grow quarter-over-quarter through the rest of 2022.

Outlook

Management's FY2022 outlook remains unchanged from that presented on January 25, 2022 when Q4 and FY2021 results were released.

Q1 sales were ~$0.25B below expectations, which equates to less than a single day of volume; LMT expects to fully recoup this throughout 2022.

For the balance of FY2022, LMT projects sales of slightly below $16B in Q2, ~$17B in Q3, and ~$18B in Q4.

Recent events which will positively impact LMT's results going forward include:

• Germany's recent announcement to procure 35 F-35 fighter jets.
• Canada's announcement that it will enter into the finalization phase of its procurement process with the US government and LMT to purchase 88 F-35 fighter jets for the Royal Canadian Air Force.

These two recent announcements follow similar award decisions in 2021 from Switzerland and Finland.

All 4 competitive wins have the potential to add 223 F-35s to LMT's backlog when all are finalized.

In Q1, the US Congress passed the FY2022 Omnibus Appropriations Act; the bill was subsequently signed into law by President Biden. This legislation improved ~$742B in Department of Defense (DoD) spending and is an increase of ~$40B over the FY2021 enacted amount. The final bill results in increases that will benefit multiple LMT programs over the next few years, including fully funding 85 F-35s, 21 additional C-130J transport aircraft, 10 additional Black Hawks, and 2 additional CH-53K helicopters as well as increases to some LMT franchise satellite and missile programs.

President Biden has also submitted the FY2023 Defense Department budget request which is the first step in the FY2023 budget process. The President’s submission adds $30B to the enacted FY2022 appropriations and $773B in requested DoD funding.

In Q1, the Sikorsky team received over $1B in orders for the CH-53K platform.

LMT also continues to see significant opportunities across the competitive new business landscape. The following are just 2 examples.

• In LMT's space business, it was awarded transport layer tranche 1, one of three prototype agreements from the Space Development Agency. The $0.7B award to design and build 42 small low-earth-orbit satellites is part of the initial tranche of the National Defense Space Architecture.
• In March, the Sikorsky team delivered its final updated prime proposal to the US Army in response to their future long-range assault aircraft solicitation.

Credit Ratings

LMT's senior unsecured domestic currency debt ratings are unchanged from the time of my previous review.

• Moody's: A3
• S&P Global: A-
• Fitch: A-

These ratings are the lowest tier of the upper-medium investment-grade level and define LMT as having a STRONG capacity to meet its financial commitments. It is, however, somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

Dividends and Share Repurchases

Dividend and Dividend Yield

LMT repeatedly states its commitment to reward shareholders through dividend increases (see dividend history).

In Q1, LMT distributed ~$0.767B in dividends versus $0.762B and $2.9B during Q4 and FY2021.

At the time of my January review, shares were trading at ~$380 and the $2.80 quarterly dividend yielded ~3%. At the time of my prior review on October 27, 2021, the yield was ~3.4%.

LMT is currently trading at ~$460 and the surge in the share price now results in a ~2.4% forward dividend yield.

The 4th $2.80 quarterly dividend is very likely to be declared in late June for distribution in late September. Looking at LMT's ~5-year dividend track record, I anticipate the declaration of a ~$0.20/share quarterly dividend increase in late September.

LMT generates ample Operating Cash Flow and Free Cash Flow to service its dividend.

Share Repurchases

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. While the weighted average diluted shares outstanding in Q1 2022 was 269.2, the diluted shares outstanding at the end of Q1 had dropped to 265.

LMT has targeted ~$4B in share repurchases in FY2022. In Q1, it executed a $2B accelerated share repurchase agreement. This leaves ~$2B on LMT's existing share repurchase authorization.

When companies have a share purchase program or enter into an accelerated share repurchase agreement (ASR), I always hope shares are being repurchased at favourable prices!

The $2B of shares repurchased in Q1 were at an average price of ~$427/share. In comparison, LMT's average cost of shares repurchased in Q4 2021 was ~$344 versus ~$350 in FY2021 and ~$366 in FY2020.

I remain confident LMT will continue to strategically repurchase a prudent number of shares at favourable valuations to enhance long-term shareholder returns.

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.

When I wrote my July 26, 2021 post, LMT was trading at ~$368. Using the $26.85 mid-point of management's FY2021 guidance, the forward adjusted diluted PE was ~13.71.

In addition, FY2021 and FY2022 guidance from 24 brokers was:

• FY2021 - mean of $26.68 and low/high of $26.46 - $27.25. Using the current share price and the mean, the forward adjusted diluted PE is ~13.8.
• FY2022 - mean of $27.89 and low/high of $26 - $29.77. Using the current share price and the mean, the forward adjusted diluted PE is ~13.2.

When I wrote my October 27, 2021 post, LMT was trading at ~$332. Management's FY2021 diluted EPS guidance was ~$22.45 resulting in a ~14.8 forward diluted PE. Its adjusted diluted EPS guidance was ~$27.17 thus giving us a forward adjusted diluted PE of ~12.2.

In addition, the two discount brokerage platforms I use reflected the following broker guidance although I believed this guidance would likely be adjusted shortly to account for the most recently released financial results.

• FY2021 - 17 brokers - mean of $22.78 and low/high of $21.88 - $27.17. Using the current share price and the mean, the forward adjusted diluted PE is ~14.6.
• FY2022 - 20 brokers - mean of $27.19 and low/high of $25.02 - $29.15. Using the current share price and the mean, the forward adjusted diluted PE is ~12.2.
• FY2023 - 14 brokers - mean of $28.52 and low/high of $26.88 - $30.05. Using the current share price and the mean, the forward adjusted diluted PE is ~11.64.

At the time of my January 25, 2022 post, LMT shares were trading at ~$380. LMT has just reported FY2021 diluted EPS of $22.76 giving us a diluted PE of ~16.7.

Management's FY2022 guidance called for $26.70 in diluted EPS. Using the ~$380 share price at the time of that post, the forward diluted PE was ~14.2.

The adjusted earnings estimates on the two discount brokerage platforms I use had not yet been adjusted to reflect the most recent results and guidance. Based on the information currently available, however, I arrived at the following forward adjusted diluted PE levels.

• FY2022 - 20 brokers - mean of $26.27 and low/high of $24.14 - $27.50. Using the current share price and the mean, the forward adjusted diluted PE is ~14.5.
• FY2023 - 16 brokers - mean of $27.81 and low/high of $25.46 - $29.05. Using the current share price and the mean, the forward adjusted diluted PE is ~13.7.
• FY2024 - 6 brokers - mean of $28.13 and low/high of $27.60 - $28.80. Using the current share price and the mean, the forward adjusted diluted PE is ~14.

The release of Q1 2022 results and the FY2022 outlook continues to reflect $26.70 in diluted EPS. However, shares are now trading at ~$462 giving us a forward diluted PE of ~17.3.

The adjusted earnings estimates on the two discount brokerage platforms I use will likely be updated over the coming days. Based on the information currently available, however, the current forward adjusted diluted PE levels are:

• FY2022 - 18 brokers - mean of $26.80 and low/high of $26.52 - $27.20. Using the current share price and the mean, the forward adjusted diluted PE is ~17.2.
• FY2023 - 20 brokers - mean of $28.19 and low/high of $25.90 - $29.10. Using the current share price and the mean, the forward adjusted diluted PE is ~16.4.
• FY2024 - 14 brokers - mean of $28.84 and low/high of $26.62 - $30.00. Using the current share price and the mean, the forward adjusted diluted PE is ~16.

We now have a company whose valuation based on forward-adjusted diluted earnings estimates makes LMT far less appealing than earlier this year.

Final Thoughts

At the time of my August 2020 holdings review, I had no LMT exposure. By the time I completed my mid-April 2021 holdings review, LMT was my 18th largest holding. LMT had subsequently risen to my 12th largest holding at the time of my January 7, 2022 holdings review.

In my January 25, 2022 post I shared the following Final Thoughts:

'As much as I think LMT is reasonably valued based on guidance, I am cautiously optimistic heightened volatility will lead to further market plunges over the coming months. Should LMT's share price get caught in any downdraft and its valuation become very attractive, I would consider adding to my position. This naturally, depends on funds availability and what other bargains might arise.'

With Russia's invasion of Ukraine, LMT's share price has gone parabolic. I now think Lockheed Martin is currently unattractively valued.

Companies in the Defense sector are in vogue, and therefore, this is not the time to acquire stocks that have been bid up. I am, therefore, limiting the purchase of additional LMT shares to the automatic reinvestment of quarterly LMT dividend income.

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.