“The Senate voted 58 - 40 to strip the defense budget for a Lockheed Martin contract for F-22s. A lot of members wanted to keep the program to keep people employed even though they think the F-22 would be abandoned. We have to get through the house decision, but the senate voting against the F-22 and Lockheed Martin is lower by 8%.” CNBC’s Power Lunch 7/21/2009
In a much anticipated vote, the Senate has approved an amendment to cut out $1.75 billion from the defense budget allotted to the purchase of seven new F-22 fighter jets. The Senate was urged to approve this measure by President Obama and Defense Secretary Robert Gates, as military officials have deemed the F-22 to be outdated and much prefer the more versatile F-35, both of which are made by Lockheed Martin (LMT). There was lobbying from many of the F-22’s component makers, which are many; Pratt & Whitney, United Technologies (UTX), Northrop Grumman (NOC), Raytheon (RTN), Boeing (BA), among others. However, this outcome should not come as a huge surprise because President Obama had made it known that he would consider vetoing any spending bill that has provisions for more F-22 aircraft. So, it is somewhat surprising that the stock has taken a rather large hit today, down as much as 9% Tuesday.
Lockheed Martin also reported earnings for the second quarter this morning that slightly beat analysts estimates. Revenue came in at $11.24 billion narrowly beating expectations of $11.14 billion. Earnings per share were $1.88 in the quarter versus consensus profit estimates of $1.81. These results are encouraging and from what we can tell there are no red flags in the announcement. However, LMT did lower its fiscal year EBIT outlook while leaving sales and earnings per share projections unchanged. The stock has traded lower all day, but was starting to recover when the Senate’s decision was announced and sent the shares down again.
At Ockham, we are not concerned by the past quarter’s performance or the loss of F-22 production, and we are reaffirming our Undervalued stance on LMT shares. We are looking at this from an equity investor’s standpoint and not a political one, and of course the lobbying for F-22 suppliers are concerned about a reported 95,000 jobs that will be effected. According to Bloomberg, the defense department plans to purchase up to 500 F-35’s from Lockheed in the next five years, and as many as 2400 over the “life of the program”. The loss of a few F-22’s is marginal when compared to the potential production of the much preferred aircraft. For the long term investor, we like the value in a company like Lockheed Martin and we believe that dips like today are an opportunity. The company is expecting to earn somewhere between $7.15 and $7.35 per share for 2009, which makes their P/E just about 10.4x.
Based on the current fundamentals of Lockheed, such as price-to-cash earnings, price-to-sales, dividends, etc, our methodology suggests a price between $87 and $108 would be an appropriate trading range. Sales have continued to steadily grow in the past and the F-22 is now a very small part of that growth. There are concerns about the government cutting spending on military and defense going forward, but based on what we know now the F-35 looks like it has a bright future.