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South Korea intends to purchase 40 F-25 fighter jets with stealth capabilities, of Lockheed Martin (NYSE:LMT), for about $7.8 billion. The company also has orders from Australia, Britain, Israel, Italy, Japan, the Netherlands, and Norway for its F-35 fighter jets. On account of growth in orders for the F-35, Lockheed Martin is expected to increase the production rate of these fighter jets from the current 29 per annum to 42 jets next year, which is expected to increase revenue generation from the F-35. Currently an F-35 costs around $115 million. As per the current production rate, I estimate that the F-35 generates revenue of approximately $3.33 billion annually. With the increase in production rate to 42 jets per annum, this revenue generation is expected to increase to $4.83 billion.

Growing operating margins

The U.S. government's cut in defense spending led Lockheed Martin to adopt cost cutting strategies. As a part of its cost cutting plan, Lockheed Martin is expected to lay off approximately 4,000 employees, which is around 3.5% of its total workforce. After these job cuts, Lockheed Martin is expected to be left with 112,000 employees. Since 2008, the company has reduced its workforce by around 23%, when it employed around 146,000 employees. Moreover, the company will close and consolidate some of its facilities located in the U.S.

Lockheed Martin plans to shut down its facilities in Pennsylvania, Ohio, Arizona, Texas, and its operations in California. These closures will result in reduction of workforce by 2,000 positions by 2015. Another 2,000 employees are expected to be eliminated from the company's various segments like 'Information Systems & Global Solutions,' or IS&GS, 'Mission System and Training,' or MST, and 'Space Systems' by the end of next year. Regarding its consolidation plan, Lockheed Martin will transition operations of its IS&GS segment to its facilities in Colorado and Pennsylvania. The potential sites for the MST segment are expected to be finalized early next year.

As per the table below, Lockheed Martin's operating margin has been increasing since 2011. Its operating income for the nine months ending on September 29, 2013 was $3.67 billion, and extrapolating this data for twelve months, I estimate the operating income for fiscal year 2013 to be $4.89 billion. Similar calculations provide the net sales estimation for this fiscal year. Lockheed Martin's cost cutting plan drives this rise in operating margin.

Fiscal year

2011 (actual)

2012 (actual)

2013 (estimated)

Operating Income ($ millions)

4,020

4,434

4,894

Net sales ($ in million)

46,499

47,182

45,099

Operating margin (%)

8.64

9.39

10.85

Going forward, as per its cost cutting strategy, Lockheed Martin expects its operating margin to be more than 11.5%. The graph below depicts this rise in the company's operating margin. The increasing operating margin suggests that Lockheed Martin is earning more on each dollar of sales, and these earnings are expected to increase going forward.

Though Lockheed Martin is cutting costs due to cuts in U.S. defense spending, its competitor Northrop Grumman (NYSE:NOC) is betting on contracts from the U.S. Air Force. On November 7, 2013, the U.S. Air Force awarded a $178 million contract to the company for its 'E-8C Joint Surveillance Target Attack Radar System,' also known as Joint STARS, which is the U.S. Air Force's battle aircraft. Northrop will provide logistics, training, and supply chain support services to the Joint STARS aircraft fleet. After this contract, the company received another contract of $114 million from the U.S. Air Force.

As per this contract, Northrop is expected to build three 'RQ-4 Global Hawk' unmanned aircrafts, which are used for the purpose of surveillance by the Air Force. These contracts are expected to boost the company's 'aerospace system' segment, which accounted for 40.68% of the company's total revenue in the third quarter of fiscal year 2013. This segment declined by 4% in the third quarter to $2.48 billion year over year.

Conclusion

The cost cutting measures are in response to the cuts in defense spending by the U.S. government, and these cuts are expected to increase Lockheed Martin's operating margins going forward. The company's F-35 jets are also vital to its growth. Along with these fundamental growth factors, the company's strong balance sheet position is marked by its long dividend distribution history. The company authorized a quarterly dividend of $1.33 per share, which is expected to be paid on December 27, 2013. This dividend is a quarter-over-quarter growth of 16%. Amassing all my discussion on Lockheed Martin, I suggest investors include this stock in their portfolio.

Source: Lockheed: Still A Safer Bet?