Can Lockheed Martin Sustain Its Dividend?

Apr.21.14 | About: Lockheed Martin (LMT)

Summary

A reduction in defense spending will ultimately reduce the company’s top and bottom lines in the future.

Cancellation of F-35 orders will further depress the company’s revenues stream in the coming years.

The U.S. defense department will save an additional $2.1 billion over the next five years by scrapping plans for two Lockheed Martin communication satellites.

Lockheed Martin Corporation (NYSE:LMT) is a leading security and aerospace company. Back in February the company announced its fourth quarter and full year results that were not up to the mark as the company failed to deliver strong revenues in 2013.

The company is strongly interlinked with the U.S. government as 82% of net sales were from the U.S. government in 2013 either as a primary contractor or as a subcontractor. Currently the U.S. government is considering cutting spending on defense and reduced the defense budget outline for 2015. So reduced spending from the U.S. government will result in low levels of sales for the company which will ultimately reduce the company's bottom line in the coming years. Let's analyze how the recent initiatives by the U.S. and Italian governments will impact the company's top and bottom lines in the coming years.

F-35 Orders:

The Pentagon recently announced that it would cut 17 of the 343 F-35 fighters it plans to buy from the company in fiscal years 2016 to 2019. Currently one jet costs $100 million and this move would save about $1.7 billion of the $45.5 billion in planned spending for the F-35s.

Italy is also considering cutting its defense spending and may cut its order for 90 Lockheed Martin F-35 fighter jets. The prime minister announced last week $14 billion in income tax cuts and the planes order would be revised as he seeks to reduce public spending. The decision has until the end of this year to be finalized. If the Italian government significantly cuts orders it will further depress the company's top line.

Currently the F-35 is the company's largest program and generates about 16% of the company's net sales. Going forward the company expects that this will remain its growth driver but recent news regarding the cutting of orders and software problems in the jets will raise many questions and uncertainties. Now I believe it will be difficult for the company to secure more orders unless it successfully resolves the software problem and the Marine Corps starts using this jet by mid-2015.

Space System:

The company's space system segment generated net sales of $8 billion and represented 18% of total net sales. But the performance of this segment in 2013 was not impressive as net sales for 2013 decreased $389 million primarily due to lower net sales for the commercial satellite program.

These communication satellites are one of the major programs for the space system segment. The 2015 budget includes $7.2 billion for these satellites and other space based products but recently the Pentagon decided to save $2.1 billion by canceling its plans to buy two communication satellites from the company. The Pentagon also said it planned to postpone work on two global positioning systems III satellites that are also to be built by the company. So this reduction will create further problems for the company as this segment is a major driver of the company's revenues. Now it seems that it will fail to provide a healthy contribution toward the company's total net sales in the coming years.

Defense Industry Outlook:

Global defense spending is declining due to affordability concerns in many traditional active governments. So far, the US government spends the most on defense and accounted for about 39% of total global defense spending but is now considering reducing its spending and shrinking the size of U.S. Army from 490,000 to between 440,000 and 450,000.

Overall the sector's growth is also likely to be diminished with the downward trend. If we analyze the overall industry the revenues and operating margins of the different companies have shown a declining trend over the past 3 to 4 years and considering the current prospects I believe that these declining trends will continue in the coming years.

Furthermore the Pentagon's anticipated five-year $550 billion budget for weapons purchases would be cut by $48.3 billion and its $337 billion research plan would be reduced by $18 billion. All of these savings by the U.S. Government are considered losses from the company's prospective because the U.S. Government is a major buyer of the company' products.

Conclusion:

Previously, it was believed that the F-35 would remain the bright spot for the company but the recent cancellation of orders and software problems will raise big questions on the future of this jet. Overall the company's position is not clear unless it considers deriving more revenues from other countries such as Brazil and China where defense spending trends remain positive.

Despite the fact that the company is going through a tough phase it has returned $1.5 billion in dividends and $1.8 billion in share repurchase in 2013 and maintained its dividend yield at a level of almost double the industry average. The future prospects that may result in a low level of earnings and less cash flow generation in the coming years will make things difficult for the company, so I suspect that the company will fail to maintain its dividend yield at current levels in the future.

Therefore I don't believe that Lockheed is an attractive investment opportunity at present and investors should consider investing elsewhere. I don't recommend buying the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.