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Summary

  • Lockheed Martin’s previous quarter saw sales falling but earnings increased thanks to cost optimization.
  • Lower defense budget is being taken care of by improving cost structure in various programs.
  • Although, the F-35 program is a major concern for investors, I believe that the Government remains committed to the program.
  • The international markets and good guidance for the year indicate that Lockheed Martin will continue reaping revenue and generating returns for investors.

It is safe to say that Lockheed Martin (NYSE:LMT) sailed through its last fiscal year with flying colors. Over the period, the defense stock gained a rewarding 40% in price appreciation. Several issues have surrounded the company and which may have caused some to doubt the company's future revenue stream. These include the heavy reliance on the US Department of Defense; 61% of sales come from the government.

Still, Lockheed Martin remains a good choice for return-seeking investors. The company is set to announce its second quarter results late this month. Before we proceed, let's quickly recall Lockheed Martin's performance during its first quarter. During its last quarter, Lockheed Martin experienced declining volumes which led to a 3% fall in total revenue to $10.7 billion. Cost of sales fell by 9% due to greater risk retirements for the C-130 program at the aeronautics and radar surveillance systems and combat systems programs at MST. We will see these reductions continue in the future. This is because Lockheed Martin is closing and merging certain facilities to reduce its total workforce by 4,000 personnel. I believe the decision was well drafted because given the present facility capacity and future workload projections, enacting cost measures has become necessary to incorporate the changes in U.S. government spending as well as the rapidly changing competitive and economic environment. Recently when the US put sanctions on Russia, the country said it would cut off the sale of its RD-180 rocket engines for use by the American military.

Growing pressure to develop additional technology in the U.S. along with a lower defense budget means that Lockheed Martin has to find a way to keep its products affordable. Otherwise, both the company and the nation would be at a drawback. This small but important issue may drive the survival strategy Lockheed Martin is considering at the moment and will highlight how the company will stay afloat.

Cost leverage and other non operating factors brought in earnings of $2.87 per share and this figure was higher than last year's result. I will not incorporate order booking in my article but will let investors know that it grew year over year. My point of focus will now divert to the recent news regarding shutting down the near $400 billion F-35 program which might have worried investors.

The plane was recently grounded because the engine caught on fire. This isn't the first time the program has faced difficulties. The F-35 is billions over budget, nearly a decade behind schedule, and inundated under technical flaws. But despite all of these problems, I am confident that the program will succeed. To begin with, U.S. lawmakers are still committed to supporting the F-35. Stopping this program would mean billions lost in research and development costs. Moreover, the authorities have concluded that the recent fire wasn't a systematic flaw. Just as any product needs to be developed, Lockheed Martin needs more time to develop and refine the plane. The company, together with two of its biggest suppliers, has agreed to invest up to $170 million of their own money to help lower the high cost of the new F-35 fighter jets. Given what has been already invested, I believe these planes will come to pass and Lockheed Martin won't recognize any loss going forward.

In addition, to doing business with the F-35 domestically, the international arena is relatively untapped by the company. The company has the potential as was evident with Raytheon which is already well positioned in the international market and recently boosted international sales to 27% of total revenue. In its last earnings call Lockheed Martin discussed that the company was working towards reaching a 20% contribution towards total revenue from international sales.

Korea has already procured the F-35 for its F-X fighter acquisition program. This year's order quantities for new aircraft are projected to increase by 20% above the previous fiscal year's levels. And the fiscal year 2015 budget projections reflect an additional expansion of over 30% in new aircraft orders for Lockheed Martin. These figures indicate growing customer demand for the aircraft.

Bottom Line

Despite budget constraints, Lockheed Martin's trailing return on equity has stood at 123%, significantly higher than the industry. With bottom line improvements, international expansion potential, and the F-35 program destined to remain in place, I don't see any reason why the weapon supplier should underperform in the future. Its dividend payout has been raised every year since 2003. A present payout ratio of 51% still offers Lockheed Martin plenty of elasticity to continue to raise payments in the near future, especially given the strong cash flows it has and the future backing of orders. For all of these reasons, I believe Lockheed Martin deserves a buy rating.

Source: Lockheed Martin Knows How To Fight The Investor Battle