Lockheed Martin - Stock Analysis Update

In my July 14, 2021 Lockheed Martin (LMT) post, I disclose the purchase of an additional 50 shares in one of the Core accounts within the FFJ Portfolio. Now that LMT has:

  • reported Q2 and YTD results on July 26;
  • increased its FY2021 guidance; and
  • investors have not reacted kindly to LMT's strong results

I have acquired an additional 50 shares at ~$369/share.

Lockheed Martin – Stock Analysis Update - Financials

Looking at LMT's Q2 and YTD results, we see Q2 diluted EPS of $6.52 and ~$17B in revenue. Both are in line with analysts' $6.53 EPS and $17B revenue expectations.

Despite posting strong results, it appears investors are fixated on performance issues on a classified program at LMT's jet-making Aeronautics business segment.

In Q2, LMT completed a comprehensive review of the classified program. It determined that estimated total costs to complete the program are expected to exceed the contract price. As a result, LMT has recorded a loss of $0.225B ($0.169B, or $0.61/share, after tax) at its Aeronautics business segment.

On the Q2 earnings conference call, senior management indicates the classified nature of the program precludes management from discussing this matter in depth. Management does, however, indicate its customer is highly attracted to the capabilities being developed on their behalf and that the long-term potential of this solution is significant for the customer.

When we remove this $0.61/share charge, LMT's Q2 results look solid. What’s more, LMT has raised its FY2021 guidance.

Free Cash Flow

During FY2010 - FY2020, 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, $5.827, and $6.417. In Q1 and Q2 2021 it generated $1.467B and $0.95B in FCF.

Business Outlook

LMT's execution over recent years has been excellent. I imagine investors were expecting the usual ‘beat and raise’ performance for Q2 and have reacted negatively to this 'special charge'. I think investors need to look beyond this 'special charge' and consider LMT's business outlook.

LMT stands to benefit from The White House's FY2022 budget proposal submitted to Congress. This proposal requests $175B for the Department of Defense which is an $11B increase from the FY2021 enacted budget. In this proposal, LMT's programs continue to be well supported. It includes over $12B for the F-35 program, ~$3.5B for LMT's signature Sikorsky helicopters, and over $2B for hypersonics programs.

Furthermore, LMT has recently been awarded considerable new business. The following achievements are just 3 examples of LMT's focus on providing innovative solutions. They also demonstrate the strength of LMT's broad portfolio to support its customers' missions and objectives.

In Aeronautics, Switzerland's Federal Council announced its decision to purchase 36 F-35A conventional takeoff and landing aircraft along with sustainment and training services as part of their Air2030 modernization program. The initial value of this contract is $5.5B and the total value is ~$15B over 30 years. Switzerland will become the 15th nation to join LMT's program since its inception.

In Rotary and Mission Systems, the US Navy awarded LMT's Sikorsky team a contract for nine CH-53K heavy-lift helicopters. This contract is worth ~$0.9B. The award also includes the option for nine additional King Stallion aircraft, which when those are exercised, would represent over $1.9B.

In Missiles and Fire Control, LMT's integrated air and missile defense line of business delivered the first PAC-3 Missile Segment Enhancement interceptors to Sweden; it now has the world's most advanced air defense capabilities to defend against incoming threats. Sweden now becomes one of 10 international customers to choose PAC-3 MSE missiles.

LMT's Space business area was selected by NASA to build spacecraft for two separate missions to Venus. LMT will design, build and operate the VERITAS orbiter to investigate the surface and subsurface of Venus and the DAVINCI+ vehicle to research the planet's atmosphere. These missions build on LMT's legacy Magellan program for the exploration of Venus and will represent NASA's first return to the planet in more than 3 decades.

Status of Aerojet Rocketdyne Acquisition

On December 20, 2020, LMT entered into an agreement to acquire Aerojet Rocketdyne Holdings, Inc. for a transaction value of ~$4.4B after the assumption of Aerojet Rocketdyne’s projected net cash. The rationale for this acquisition is to enhance LMT's and the industry's ability to meet future national security and civil space objectives when it comes to propulsion.

Aerojet Rocketdyne’s stockholders approved this acquisition on March 9, 2021.

This deal has raised eyebrows because it would give the #1 defense contractor (LMT) ownership of a vital piece of the US missile industry whose motors are used in everything from the homeland missile shield to Stinger missiles.

LMT has stated that after the deal closes, the Aerojet Rocketdyne business will continue to serve as a merchant supplier to the entire defense industry. This has been met with skepticism by Raytheon Technologies (RTX) which is a major customer for rocket motors.

After this takeover offer, US Senator Elizabeth Warren, who has a keen interest in corporate behaviour, asked the Federal Trade Commission (FTC) to examine the premise and efficacy of internal firewalls like those LMT proposes to prevent it from gaining a competitive advantage over peers once the deal closes. She has urged the FTC to take a stronger antitrust stance on defense deals and has recommended the LMT tie-up not be allowed until the FTC understands the effectiveness of past internal firewalls; the purpose of internal firewalls is to protect competitor intellectual property, pricing, and product progress in the highly competitive weapons business.

A firewall is an example of a 'behavioural remedy'. Such remedies, one of the tools the FTC has to preserve competition, usually expire after a few years. Senator Warren has inquired if 'behavioural remedies' have protected competition and prevented monopolistic behaviour in the defense industry.

An alternative to a 'behavioural remedy' is a 'structural remedy'. This is a more common enforcement mechanism and generally requires a company to sell a line of business to prevent monopolistic behaviour.

In February 2021, the FTC extended its review of the deal under the Hart-Scott-Rodino Act to scrutinize potentially anti-competitive mergers. LMT is in the process of responding to the FTC's 2nd request for information which it received earlier in 2021 and it continues to expect the deal to close in Q4 2021.

Should the FTC grant its approval, LMT would finance the acquisition through a combination of cash on hand and new debt issuances.

Lockheed Martin – Stock Analysis Update - Credit Ratings

I am not prepared to assume unnecessary risk with my investments at this stage of my life. Furthermore, I am cognizant that as an equity investor I assume a greater level of risk than debt holders. I, therefore, pay attention to a company's credit risk and shy away from companies where the unsecured debt is non-investment grade.

LMT's senior unsecured domestic currency debt ratings from the 3 major rating agencies are at the lowest tier of the upper-medium investment-grade level.

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

These ratings 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.

Lockheed Martin - Stock Analysis Update - Dividends and Share Repurchases

Dividend and Dividend Yield

In Q2, LMT distributed ~$0.721B of dividends.

We see from LMT's dividend history that its 4th quarterly $2.60 dividend with be distributed on September 24th. Based on the current ~$368 share price this yields ~2.83%.

As indicated in my July 14th post, I think LMT will announce an increase in its quarterly dividend to ~$2.70 - ~$2.80 in the last week of September; LMT generates ample Operating Cash Flow to support its dividend.

Share Repurchases

LMT continues to reduce its share count with the diluted weighted average shares outstanding in FY2011 - FY2020 (in millions) of 340, 328, 327, 322, 315, 303, 291, 287, 284, and 281. This has been further reduced to 279.1 (refer to page 1 of 7 in the Q2 Financial Tables) through the YTD repurchase of $1.5B of issued and outstanding shares.

Lockheed Martin – Stock Analysis Update - Valuation

In FY2013 - 2020, LMT's diluted PE levels were 16.02, 19.47, 19.27, 18.81, 26.04, 24.80, 18.51, and 15.16.

When I wrote my July 14, 2021 post, LMT was trading at ~$375.60. Using the $26.55 mid-point of management's FY2021 guidance I arrived at a ~14.2 forward adjusted diluted PE.

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 ~14.1.
  • 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 ~13.5.

This mid-point of management's FY2021 guidance is now $26.85 and the share price is ~$368. On this basis, the forward adjusted diluted PE is ~13.71.

This valuation is even more attractive than at the time of my July 14th share purchase.

Lockheed Martin – Stock Analysis Update - Final Thoughts

Fortunately, investors have shaved $12.72 or $3.34% from the previous day's close following the release of Q2 results on July 26th! I am grateful when the share price of a high-quality company suffers because of an issue that does not detrimentally impact the company for the long term.

Given this knee-jerk reaction, I have acquired another 50 shares on July 26th in one of the 'Core' accounts within the FFJ Portfolio.

Raytheon Technologies (RTX), one of LMT's key competitors, releases Q2 results on July 27th. I will be covering RTX in a guest post at Dividend Power which will be posted sometime in early August.

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 do not know 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 and RTX.

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.