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Lockheed Martin (NYSE:LMT) is the largest and Northrop Grumman (NYSE:NOC) the 6th largest defense contractor in 2013 according to the Defense News Top 100. Fundamentals and business strategy are key elements when comparing.

The main focus of this article is aerospace. It is the second article on the aerospace industry after the comparison of Boeing (NYSE:BA) and Airbus (OTCPK:EADSF) in the battle for leadership.

OVERVIEW

Lockheed Martin20122011201020092008
Revenue$47,182$46,499$45,671$43,995$41,372
Net income$2,745$2,655$2,878$3,024$3,217
Dividend$4.15$3.25$2.64$2.34$1.83
Dividend yield2.79%
EPS$8.36$7.81$7.81$7.78$7.86
PE17.77
EBIT$4,434$4,020$4,105$4,415$5,049
EBIT%9.40%8.65%8.99%10.04%12.20%
EBITDA$5,422$5,028$5,157$4,861$5,466
EBITDA%11.49%10.81%11.29%11.05%13.21%
FCF$619$3,266$2,727$2,321$3,495
ROA7.10%7.00%8.20%8.61%9.62%
ROCE16.73%15.59%17.31%18.09%22.05%

(x 1m with the exception of Dividend and EPS, Stock price used for PE and dividend yield is $148.52)

Northrop Grumman20122011201020092008
Revenue$25,218$26,412$28,143$33,755$32,315
Net income$1,978$2,118$2,053$1,686-$1,262
Dividend$2.15$1.97$1.84$1.69$1.57
Dividend Yield1.87%
EPS$7.81$7.52$6.82$5.21-$3.77
PE14.75
EBIT$3,130$3,276$2,827$2,483-$263
EBIT%12.41%12.40%10.05%7.36%-0.81%
EBITDA$3,640$3,820$3,382$3,033$300
EBITDA%14.43%14.46%12.02%8.99%0.93%
FCF$2,309$1,623$1,868$1,377$2,357
ROA7.45%8.33%7.45%5.57%-4.18%
ROCE15.28%17.00%14.76%10.67%-1.16%

(x 1m with the exception of Dividend and EPS, Stock price used for PE and dividend yield is $115.19)

  • Lockheed Martin has a higher dividend yield but also a higher PE;
  • Lockheed Martin has a much lower FCF and has dropped, while Northrop Grumman's FCF has gone up;
  • Northrop Grumman has a lower PE and the trend shows that profitability is increasing;
  • Lockheed Martin's profitability is lower compared to the past. There is no clear trend visible.

click to enlarge images

The activities of both Lockheed Martin and Northrop Grumman are diverse but information systems and aerospace have enough in common to do a sensible comparison.

Financial Data Sources

All financial data used is from financial reports published by Lockheed Martin and Northrop Grumman.

Aeronautics

Lockheed Martin20122011201020092008
Revenue$14,953$14,362$13,109$12,201$11,473
EBIT$1,699$1,630$1,498$1,577$1,433
EBIT%11.36%11.35%11.43%12.93%12.49%

Lockheed Martin is the largest manufacturer of combat aircraft in the United States. The F-22 Raptor and the F-35 Joint Strike Fighter are the latest leaves on this branch.

The F-35 program has serious issues which are covered in the risks below. Lockheed also has a range of (tactical) transport aircraft such as the very successful C-130 Hercules.

Northrop Grumman20122011201020092008
Revenue$9,977$9,964$10,436$10,419$9,825
EBIT$1,218$1,217$1,213$1,071$416
EBIT%12.21%12.21%11.62%10.28%4.23%

Northrop Grumman specializes in manned and unmanned aircraft such as the RQ-4 Global Hawk and E-2 Hawkeye. Most aircraft have advanced electronics for information gathering, early warning or electronic warfare tasks. Northrop Grumman is market leader in this niche without important competitors anywhere in the world.

Lockheed Martin's revenue is getting bigger, but profitability is not. Northrop Grumman is the other way round. Revenue is getting less, but profitability is rising.

Information Systems

Lockheed Martin20122011201020092008
Revenue$8,846$9,381$9,921$9,608$9,069
EBIT$808$874$814$1,011$1,076
EBIT%9.13%9.32%8.20%10.52%11.86%

Lockheed Martin provides (ICT related) services to a broad range of (government) clients with applications ranging from cybersecurity to human resources.

Northrop Grumman20122011201020092008
Revenue$7,356$7,921$8,395$8,536$8,174
EBIT$761$766$756$624$626
EBIT%10.35%9.67%9.01%7.31%7.66%

Northrop Grumman is more focused on defense related services such as cybersecurity, command and control and communications.

A similar pattern emerges in Information Systems. Lockheed Martin's profitability seems to be going down while Northrop Grumman is going up.

RISKS

Both Lockheed Martin and Northrop Grumman are extremely dependent on the US Government:

  • 82% of Lockheed Martin's revenue (and even more if Foreign Military Sales through the US Government are included);
  • 90% of Northrop Grumman's revenue is from the US Government.

Budget cuts or a Government shutdown such as October 2013 will have an immediate effect on revenues and results.

Lockheed Martin also has a troublesome relation with the Pentagon on the F-35 Joint Strike Fighter program. Air Force Secretary Michael Donley told reporters in September 2012:

"The department is done with major restructures that involve transferring billions of dollars into the F-35 program from somewhere else in the defense budget. There's no further flexibility or tolerance for that approach"

The relation seems still problematic. Although F-35's are being delivered to the USAF and foreign customers (for testing), there are still a lot of problems that have to be resolved. This article gives a good background with sources on the JSF issues.

CONCLUSION

Both Lockheed Martin and Northrop Grumman are very dependent on the US Government as their primary client. This is risky but both can expect continuing orders (as there aren't many competitors).

When reviewing the quarterly updates the general trend for both companies is that revenues are decreasing for both of them. Getting leaner by internal cuts will probably improve results.

Better results are unlikely: budget cuts and the shutdown will have a negative influence.

Northrop Grumman is the better investment of the two, but wait until the final results for 2013 are published before investing.

Northrop Grumman has a clear focus on activities and is market leader in an important and profitable segment. Reorganization (and divestment in the past) was successfully implemented and overall the performance is improving.

The problematic relation between Lockheed Martin and the US Government should not be underestimated. Maybe it is getting better, but it will take time to heal. This is a major unknown factor.

Lockheed Martin definitely has strong activities, but seems less focused (in activities and actions) than Northrop Grumman. Profitability will benefit from a strategic review and divestment of non-core activities.

Source: Lockheed Martin And Northrop Grumman: Comparing The Contractors