In a world where geopolitical tensions run high and national security becomes an ever-growing concern, defense companies play a crucial role. Among these industry titans, Lockheed Martin (NYSE:LMT) emerges as a leading figure with a competitive edge grounded in a diversified portfolio and an unwavering mission-first culture. This article examines the company’s core strengths, potential risks, and financial performance, shedding light on LMT’s investment potential. Despite some headwinds and emerging threats, we believe Lockheed Martin’s strategic positioning and financial stability offer potential value for long-term investors.
Understanding Lockheed’s Competitive Advantage
At the heart of Lockheed Martin’s competitive edge lies a mission-first culture that truly sets it apart from its competitors. As we analyze this industry powerhouse, the core differentiator becomes clear: its portfolio. Lockheed operates as a prime system integrator, centered on prime weapons systems. With prominent offerings like the F-35 fighter jet, Black Hawk helicopters, Javelin missiles, and a broad range of space technology, the company presents an impressive and diversified portfolio that spans from subsurface to satellite. This depth and breadth are matched by only a handful of companies worldwide.
The relevance and flexibility of Lockheed’s offerings are seen in its response to changing customer needs. A prime example of this lies in the space sector, where clients are shifting their focus from multi-mission satellites to more specific, single-mission units. This disaggregation of the constellation is driven by an increased need for resilience against threats to space assets. While some may see this as a potential setback for Lockheed Martin, we see the company’s ability to quickly adjust to this new reality as a testament to its robust business model and mission-first culture.
What really seals the deal for Lockheed is what we call “mission stewardship.” Having been in the business for decades, Lockheed Martin isn’t just a contractor; it’s a partner with a deep understanding of the missions it supports. The company has an uncanny ability to anticipate customer requirements and collaborate with the government to create new requirements and architectures for future challenges. This strong incumbency creates a formidable barrier to entry for any potential competitors.
Furthermore, Lockheed’s longevity in the industry gives it an unparalleled advantage over disruptive start-ups. These newcomers may bring innovation and enthusiasm, but what they lack is the depth of experience and understanding that only comes with time. Lockheed’s intimate knowledge of the missions it serves, and its role as a trusted partner to its customers, is not something that can be quickly or easily replicated.
We view Lockheed Martin’s strong mission-first culture, its diversified portfolio, and its intimate understanding of its customers’ missions as core strengths that solidify its position in the industry. We believe that these factors make Lockheed an attractive investment opportunity. However, as always, investors should consider their individual investment goals and risk tolerance when making decisions.
Risks
Looking ahead, Lockheed Martin faces significant risks within the next 12-24 months, some of which are already materializing. The inherent nature of its business, characterized by large government contracts, brings along a unique set of challenges known as binary program risks. Case in point, the recent awarding of the Future Long-Range Assault Aircraft (FLRAA) program to Bell Textron (TXT), which is set to replace the Black Hawk helicopters, a stronghold of LMT’s Sikorsky division. This significant blow to Lockheed Martin’s future strategy exemplifies the potential downside of binary program risk.
Additionally, the shift in the US government’s approach to space-based early warning systems, moving away from geosynchronous orbit (GEO) spacecraft to low-earth orbit (LEO) spacecraft, poses a serious threat to LMT’s space business. For decades, the company has been a prime contributor to programs such as the Space-Based Infrared System (SBIRS) and the Next Generation Overhead Persistent Infrared (OPIR). The recent decision not to select Lockheed Martin for the Space Development Agency’s (SDA) missile warning constellation further deepens this concern.
Being a premier defense company with a robust portfolio and legacy of successful programs, any disruption or loss in these key projects equates to sizable holes in Lockheed Martin’s portfolio. In our opinion, this vulnerability to major shifts in government defense strategy and program selection forms the most significant risk LMT faces today.
Investors should closely monitor these developments, as any further losses in strategic contracts could adversely impact the company’s long-term growth prospects and financial health. That being said, the robustness of LMT’s overall portfolio and its entrenched position in the defense industry shouldn’t be disregarded. Nevertheless, these potential headwinds could significantly impact the company’s future performance.
Financial & Valuation
Note: All historical data in this section comes from the company’s 10-K filings, and all consensus numbers come from FactSet.
Lockheed Martin’s Q1 earnings results were released on April 18, 2023, with the stock gaining 2.4% on the back of these results. Their revenues grew marginally by 1.1% y/y to $15.1 billion, matching consensus estimates, and they managed to slightly expand their operating margin to 13.5% from 12.9% a year ago. While this isn’t staggering growth, it’s a positive sign in a market hungry for consistent performance.
However, the projected financial trends for LMT reveal a mixed bag. Over the past three fiscal years, their revenue has grown at a CAGR of 3.3%, which is respectable, but the sell-side consensus predicts a minor contraction of 0.3% in revenues this fiscal year, expected to reach $65.8 billion. This forecasted slowdown in growth, even though slight, is somewhat concerning since it reflects the company’s program mix shift.
The consensus predicts LMT’s EBIT margin to expand marginally this fiscal year to 12.9%, followed by a contraction to 12.7% in the following year, continuing the downward trend observed over the past three fiscal years. Here, too, we aren’t seeing the positive momentum we’d like.
However, LMT has been effectively managing its share capital. Over the past three years, they’ve decreased their diluted outstanding common shares by 10.7%, suggesting a proactive strategy in managing shareholder dilution through share buybacks. The result is a healthier EPS, which is predicted to increase significantly by 25.3% to $27.13 this fiscal year, a figure that is promising for potential investors.
A look at LMT’s free cash flow reveals another positive trend. The company’s free cash flow for this fiscal year is expected to reach $6,270 million, a decent FCF margin of 9.5%, compared to four fiscal years ago where it stood at $5,827 million, a margin of 9.7%. This signifies an improvement in cash flow generation over time.
LMT’s capital expenditure as a percentage of revenue has averaged 2.6% over the past four fiscal years, suggesting a business that is surprisingly capital light. This means they aren’t heavily reliant on capital expenditure to generate revenue, which is advantageous in maintaining healthy profit margins.
On the balance sheet front, LMT carries a net debt of $13.1 billion, which is 1.3 times its expected current-year EBITDA of $9.9 billion. While not insignificant, this level of leverage is manageable for a company of Lockheed’s size and earning potential. Their strong return on invested capital at 23.2% and a decent dividend yield of 2.6% (109 bps above the S&P 500) further demonstrate its financial strength.
As of now, LMT trades at $454.49 per share, which gives it a market value of $115.1 billion and an enterprise value of $128.2 billion. Over the past year, LMT returned 1% points less than the S&P 500, or 7.6% in absolute terms, performing modestly in a market that can often be brutal to those who underdeliver.
When comparing LMT’s valuation multiples with the S&P 500, LMT trades at a discount in all the key ratios – EV/Sales, EV/EBIT, P/E, and FCF. This, in our view, makes it an attractive buy for value-seeking investors. But it’s worth noting that LMT’s PEG ratio is at a significant premium compared to the S&P 500, which suggests that investors have a greater degree of confidence in the reliability of the company’s growth.
In terms of historical valuations, the stock’s current PE ratio stands at 16.6, slightly above its 5-year mean of 15.3. This is within its 2-standard deviation range of 12.1 to 18.5, indicating that the stock is trading on the higher end of its historical valuation range but is not at an extreme level.
On a peer comparison basis, LMT’s forward 12-month P/E stands at a relative discount to Northrop Grumman’s (NOC) P/E of 18.9, but it is slightly above General Dynamics’ (GD) P/E of 15.7. This puts LMT in the middle of the pack in terms of valuation among its defense industry peers.
Summing up, our analysis reveals a mixed performance by Lockheed Martin. On the one hand, the company has demonstrated its financial strength through a decent free cash flow, a capital-light business model, and an effective share buyback strategy. On the other hand, the slower growth rates and contracting margins are areas of concern. However, given the current discount at which LMT is trading relative to the S&P 500 and its peers, we believe there is value to be found in this stock, especially for long-term investors seeking stability and dividend income.
Conclusion
Our evaluation paints a picture of Lockheed Martin as a company that successfully leverages its mission-first culture, diversified portfolio, and deep-seated industry understanding to maintain its market position. Despite significant risks, including binary program risks and shifts in defense strategy, LMT has shown a degree of resilience and adaptability. Financially, the company exhibits solid strength in its cash flow and capital management, even as it faces concerns with contracting margins and slower growth.
In terms of valuation, LMT currently trades at a relative discount to the S&P 500 and its industry peers, presenting an attractive proposition for value-seeking investors. However, investors should carefully consider their individual investment goals and risk tolerance, as well as closely monitor developments affecting strategic contracts and program selections.
In the complex and ever-evolving landscape of the defense industry, Lockheed Martin’s long-term viability and strength remain compelling. The company’s legacy, expertise, and adaptability may offer a potential buffer against market headwinds and shifting strategies, positioning it as a worthwhile consideration for long-term, risk-tolerant investors.
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