Lockheed Martin (NYSE:LMT)
- Share Price: $89.5
- Intrinsic Value: $111
- Buy Below: $90
Business description and background:
Lockheed Martin Corporation engages in the research, design, development, manufacture, integration, operation, and sustainment of advanced technology systems and products in the areas of defense, space, intelligence, homeland security, and government information technology in the United States and internationally. The company operates in four segments: Aeronautics, Electronic Systems, and Information Systems & Global Services (IS&GS), and Space Systems. Lockheed Martin Corporation was founded in 1909 and is based in Bethesda, Maryland.
With estimated 2011 sales of $47 billion, LMT is the world's largest military weapons maker. In 2010, the company derived 84% of its net sales from the U.S. government, including the Department of Defense (DoD) as well as non-DoD agencies. Sales to foreign governments contributed 15% of net sales (up from 13% in 2009), with 1% of net sales to commercial and other customers. Lockheed Martin conducts business through four operating segments: Aeronautics; Electronic Systems; Space Systems; and Information Systems & Global Services.
The law passed by Congress will cut into planned defense spending significantly, but it is not yet clear how much. In a best case scenario, which would include no further cuts, the base budget will fall slightly from FY11's $529 bn into the ~$527 bn range in both FY12 and FY13. In the worst case, Congress could fail to agree on further deficit reduction and the bill's trigger provisions would take effect, in which case the DoD base budget would drop to ~$472 bn in FY13. This will be a dire scenario for the DoD and industry, and therefore it is unlikely to occur, despite the fact that avoiding it means Republicans will likely have to agree to tax increases of some variety (likely the elimination of tax expenditures/deductions) and Democrats to entitlement cuts, which neither side has been willing to do thus far. One can assume a middle of the road outcome and organic growth forecasts in which Congress cuts defense spending by an incremental $180 bn over nine years, which would take the base budget to ~$508 bn in FY13.
LMT had a spectacular year in 2011, returning 21% compared to only 1% for the other defense primes on average. In addition, while not all companies have reported yet, it is likely that LMT, at 2%, will be the only defense prime to deliver y/y organic growth in 2011. The stock no longer looks as cheap as it did entering last year, and with its dividend already at attractive levels it is unlikely that the company will substantially increase its dividend this year as it did last September. With its valuation more in-line with peers, a challenging fundamental outlook, and no clear catalysts may restrict the relative upside for the stock now. In addition, the F-35 program will continue to face a budget threat as long as the fiscal situation remains unsustainable. The budget situation could still rear its head again this year as sequestration is still the law of the land, and as long as this is the case we see continued overhang on the F-35 program
While defense companies face organic sales declines in the coming years, balance sheets should remain strong and cash flows dependable, enabling management teams to continue returning cash to shareholders. Like many other defense companies, Lockheed Martin Corp has also approved up to $1 billion in August 2011 to an existing stock buyback program started in October 2010. The defense company's board of directors is expected to consider its next share repurchase program this fall. Defense companies have already been willing to return cash over the past several years, though the preferred vehicle-buybacks may be suboptimal, and direct transfers in the form of dividends would be preferable. Repurchases in the current environment is likely to be a bet on future defense budgets. To the extent that companies do return cash, however, it would be better to prefer special dividends to share repurchases. The lack of any substantial special dividends in recent years amidst the large volumes of cash that have been poured into share repurchase maybe a substantial and unnecessary risk to shareholder value. The stocks of the five leading defense large caps (excluding Boeing) now trade 20% below the average price at which they have repurchased stock over the past five years. This share repurchase activity has involved a very substantial use of cash - in total the five companies over the five years have repurchased $32 bn of stock, which for perspective represents 39% of their combined market caps today.
Demand for military equipment and systems are primarily driven by growth in the procurement and R&D sectors of the U.S. defense budget. Based on U.S. Department of Defense statistics, from FY 00 (Oct.) through FY 10, the procurement and R&D budgets within the U.S. defense budget expanded at compound annual rates of 9.0% and 7.6%, respectively. However, Standard & Poor's expects defense budgets to decline going forward, due to pressure resulting from high U.S. budget deficits and increased entitlement spending.
Return on invested capital, adjusted to exclude a large decline in stockholders' equity in 2008, was 17.9% in 2010 and 20.0% in 2009. The Aerospace & Defense industry recorded an average return on invested capital of 15.7% in 2010 and 14.6% in 2009. Free cash flow as a percentage of sales was 6.0% in 2010 and 5.1% in 2009, versus an industry average of 6.7% in 2010 and 7.5% in 2009.
Management & Stewardship
Lockheed boasts of a strong and commendable management team with industry stewards. Robert J.Stevens is the Chairman and CEO of Lockheed Martin since April 2005. He is an industry veteran with over 30 years of experience in various organizations within government sectors including but not limited to Mosanto Company, Air Traffic management. Mr. Kubasik has served as President and Chief Operating Officer of LMT since January 2010. He previously served as Executive Vice President - Electronic Systems from September 2007 to December 2009, and as Chief Financial Officer from February 2001 to August 2007. Among its executive vice president's one can count Ralph D.Heath. Mr. Heath has served as Executive Vice President since January 2005. He previously served as Executive Vice President and General Manager of the F-22 Program from November 2002 to December 2004.
The management and other insiders own around 0.1% of the company.
We have used the DCF valuation using conservative estimates to arrive at the fair value of LMT at $111 which represents a 23% premium to its current trading price.
Disclosure: I am long LMT.
Disclaimer: This discussion is for informational purposes and should not be taken as a recommendation to purchase any individual securities. Information within this discussion and investment determination of the author may change due to changes in investment strategy when warranted by changing market conditions, or if a security’s underlying fundamentals or valuation measures change. There is no guarantee that, should market conditions repeat, this security will perform in the same way in the future. There is no guarantee that the opinions expressed herein will be valid beyond the date of this presentation. There can be no assurance that the author will continue to hold this position in companies described herein, and may change any of his position at any time. We use or best efforts to obtain good data in our models, however it can’t be guaranteed that our inputs and data are correct. This is not a recommendation for readers to purchase shares in the above security without consulting your financial professional to discuss your own risk tolerance and objectives.