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Regretably, the world in which we live is one in which Lockheed Martin Corporation's (LMT) capabilities will continually be required.
Based on my outlook for LMT and my desire to increase my exposure to the Aerospace and Defense industry, I have initiated a position in the FFJ Portfolio.
Summary
- LMT is a prime contractor on the F-35, the largest weapon program in history. This should deliver stable revenue for decades through procurement and sustainment.
- It operates in an industry which moves independent of the overall state of an economy which should offer some protection during economic downturns.
- Sales are heavily dependent on U.S. military funding. This is inherently political so this dependency can be positive and negative.
- LMT's growth is derived from a steady stream of contracts that are fulfilled over decades.
- At the end of Q3 LMT had an order backlog of $150.4B of which $~$57.8B was Aeronautics, ~$30.3B was Missiles & Fire Control, ~$36.1B was from Rotary & Mission Systems, and ~$26.3B was Space.
- An ~8.3% increase in its quarterly dividend to $2.60/share from $2.40/share was recently announced. This increase is effective with the December 24th dividend payment.
- LMT recently increased its share repurchase authority by $1.3B.
Introduction
My exposure to the aerospace and defense industry has been limited to my investment in Raytheon Technologies Corporation (RTX) and in this recent article I disclosed that I had increased my exposure by acquiring additional shares within one of the Core accounts within the FFJ Portfolio.
I have now acquired shares in Lockheed Martin Corporation (LMT). LMT is a global security and aerospace company principally engaged in the research, design, development, manufacture, integration and sustainment of advanced technology systems, products and services. It also provides a broad range of management,engineering, technical, scientific, logistics, system integration and cybersecurity services.
Should you be unfamiliar with LMT, I encourage you to review all of LMT's capabilities which fall under LMT's core business areas. Details on LMT's advanced technologies and capabilities can be accessed here.
I can appreciate how some investors may be reluctant to invest in LMT given the nature of some of the products it produces. From my perspective, however, LMT's products are a necessary evil given that not all 'country heads' are 'sane'.
Business Overview
The company was founded over 100 years ago. Click here if you are interested in learning about the company's history and wish to learn about the remarkable people and the little-known histories behind the achievements that shaped LMT.
A comprehensive overview of LMT can be found in Part 1 of the 2019 Annual Report.
LMT's sales are heavily dependent on U.S. military funding. It operates in an industry which moves independent of the overall state of an economy so economic downturns are less likely to negatively impact LMT's performance as we would expect from companies which operate in highly cyclical industries.
It is a prime contractor on the F-35, the largest weapon program in history. This accounts for ~30% of LMT's revenue and will be sustained through 2070. Essentially, we can expect stable revenue for decades through procurement and sustainment. Furthermore, this is an industry in which margins are regulated, markets are mature, and customers pay for LMT's R&D.
Q3 2020 and YTD Results
On October 20, 2020, LMT released its Q3 results and same can be accessed here; the Q3 Earnings Presentation can be viewed here.
Management has indicated that the COVID-19 pandemic has presented unprecedented business challenges with impacts in each business area. These have been primarily in increased coronavirus-related costs, delays in supplier deliveries, impacts of travel restrictions, site access and quarantine requirements, and the impacts of remote work and adjusted work schedules.
Looking at page 21 of the Q3 Earnings Release we see details on the quarter's and YTD deliveries and order backlog. We can see from page 21 in the Q1 and Q2 Earnings Releases that aircraft deliveries suffered earlier in the year as a result of COVID-19. With 1 quarter remaining in the current fiscal year I think it is unrealistic to expect LMT to meet/exceed FY2019 deliveries.
In the first 3 quarters of the current fiscal year, LMT has generated a ~13.1% consolidated operating margin versus ~14.6% for the same period fiscal 2019. This erosion in operating margin is primarily attributed to challenges attributed to COVID-19.
FY2020 Outlook and FY2021 Guidance
Looking at page 3 of each quarterly report for which links have been provided above, we see that guidance has been steadily revised upwards.
LMT has also indicated that it expects FY2021 net sales to increase to greater than or equal to $67B ($59.812B in FY2019). Total business segment operating margin in FY2021 is expected to be in the 10.9% - 11% range and cash from operations is expected to be greater than or equal to $8.1B, net of $1.0B of planned pension contributions. Additional preliminary FY2021 trends were provided during the Q3 Earnings call with analysts and are reflected below.
Source: LMT - Q3 2020 Earnings Presentation - October 20, 2020
During FY2010 - FY2019, LMT generated free cash flow (FCF) of (expressed in billions) $2.727, $3.266, $0.619, $3.710, $3.021, $4.162, $4.126, $5.299, $1.860, and $5.827. In the current fiscal year it has generated ~$5.3. Generating FCF to this degree provides management with considerable flexibility to enhance shareholder value.
Credit Ratings
When looking at a company's risk profile I keep in mind that ratings agencies assign ratings to a company's debt. Debtors rank higher than common shareholders in the event of default so I am very reluctant to invest in a company whose debt is rated as speculative.
In early December 2019, Moody's upgraded LMT's senior unsecured domestic currency debt to A3 from from Baa1. A3 is the lowest tier in the upper medium grade category and is investment grade.
In early May 2019, S&P Global revised upwards LMT's long-term local currency debt to A-; this is equivalent to Moody's A3 rating. S&P Global affirmed this rating in mid-May 2020.
Valuation
LMT has generated $17.92 in YTD diluted EPS. In Q3, however, it incurred a $55 million ($0.20 per share) non-cash charge resulting from the resolution of certain tax matters related to the former IS&GS business divested in 2016. If we add back this non-cash charge to the $17.92, we get YTD diluted EPS of $18.12. We also see that management has provided FY2020 diluted EPS from continuing operations guidance of ~$24.45.
Using the ~$369/share price at which I acquired 200 shares, we get a forward diluted PE of ~15.1 which is lower than the 16.02, 19.47, 19.27, 18.81, 26.04, 24.80, and 18.51 levels recorded in FY2013 - 2019.
In my opinion, LMT is fairly valued.
LMT's dividend history can be accessed here and its stock split history can be accessed here.
We see that on September 25th, LMT declared a $2.60 quarterly dividend which is payable December 24th to shareholders of record as at December 1st. This dividend represents a ~8.3% increase from its previous $2.40 quarterly dividend.
On the basis of my ~$369 purchase price, the dividend yield is ~2.8% (($2.60 x4)/$369). The shares I have acquired are held in a taxable account, and therefore, I will incur a 15% withholding tax on the quarterly dividend payments; my dividend yield drops to ~2.4%.
LMT continues to reduce its share count with the diluted weighted average shares outstanding in Q3 2020 being 280.6 million - down from 282.6 million and 280.8 million as at the end of Q1 and Q2 respectively. In addition, LMT increased its share repurchase authority by $1.3B with $3.0B in total remaining authorization for future repurchases of common stock under the program as of Sept. 27, 2020.
Final Thoughts
Although there appear to be few relatively low risk and attractively valued companies with reasonable growth prospects in which I wish to invest, there are a few. LMT appears to be one of them and on the basis of my analysis I acquired 200 shares @ ~$369/share for one of the core accounts within the FFJ Portfolio.
Stay safe. Stay focused.
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].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long LMT.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
