I grew up some 15 miles from a SAC (Strategic Air Command) base. I used to lie on my back in the schoolyard grass gazing heavenward as the lumbering refueling tankers floated by and watch fighters streak through the blue, anticipating the thunderous sonic boom that almost always followed. The sky was checkered with contrails and the cold war was at its zenith.
Times have changed. No Cold War. But I still have a fascination with military aircraft. Like many in my generation, I understand the importance of a strong defense capability. I like to keep tabs on defense company stocks. If the defense industry is sound, our country is safer.
With that said, let's take a look at Lockheed Martin (LMT) from a value investor's perspective. Shares are trading close to the $90 mark. Lockheed is a large cap approaching $29 billion with a trailing twelve month price to earnings ratio of 11.39 suggesting the stock might be a bargain. The price to earnings growth ratio is slightly less promising, reporting in some 56 basis points above the ideal. Price to book is exceedingly high compared to what traditional value investors would consider acceptable at 28.77. Lockheed's return on equity, however, would exceed anyone's expectations at 118.59%. Quarterly year-over-year revenue and earnings growth are mired in negative territory at -4.30 and -28.90, respectively. As we move to the fundamentals signaling financial strength, value investors are again disappointed. Debt to equity and current ratios are 645.36 and 1.16, respectively. The former is abysmal and the latter, while 'textbook', doesn't mean much in view of the former. Lockheed does pay a fairly robust dividend, yielding 3.4%, supported by a fairly reasonable payout ratio of 42%. The fundamentals, taken as a whole, aren't terribly impressive.
Before we press the eject button, I think we should research this company in more depth. After all, it has prospered for more than a century and is the wellspring of many premier fighter planes in our time; the F-16 Falcon, F-22 Raptor and most recently the F-35 Lightning II. Lockheed has also produced the greatest names in military air transport, such as the Hercules, Galaxy, and Super Galaxy airlifters.
I dove into the income statement and observed that revenues and gross profits have been basically flat for the past 3 fiscal years. Net income has declined at an average of 5% annually. Total stockholder equity has plummeted by almost 75%. To this grim scenario, add the failure of congress to enact voluntary budget cuts, which may result in $500 billion in automatic cuts in defense spending, effective January, 2013, and the future of Lockheed begins to come into question. All this negativity could turn on a dime, however. Lockheed's future is largely staked on the F-35 and its variations. Much as a new therapeutic drug works its way the maze of tests, twists and turns that is the Federal Drug Administration, so wends the F-35F through the Department of Defense and, of course, the various congressional oversight and budget committees. So does this reduce investment in Lockheed to a gamble, much in the same way an investment in most biotechnology stock is a gamble? Noted value investing guru John Shapiro of Chieftain Capital Investments has slashed his holdings in Lockheed by 23% but, he hasn't closed his position entirely. Read into that what you will.
Other defense contractors are facing challenges as well. The Boeing Company (BA) is trying to cash-in on Lockheed's software problems with the F-35. Boeing manufactures F/A-18 E/F Super Hornets and is pressing lawmakers and the Pentagon for $2 billion in additional funds to keep production alive. There are thousands of jobs at stake across several defense contractors which may influence lawmakers to aid Boeing in its quest to keep the Super Hornet alive. This would be a blow to Lockheed.
Boeing is broadly diversified compared to Lockheed. Boeing has a substantial presence as a manufacturer of civilian aircraft and would undoubtedly be in a position to weather the loss of the Super Hornet. Lockheed, however, isn't in a favorable position to lose the F-35 Lightning.
Boeing has a market cap more almost twice that of Lockheed and trades at about 14 times trailing twelve month earnings. It has a superior price to book at 15.69 and a return on equity that exceeds Lockheed's by 5.4%. Boeing's quarterly year-over-year revenue and earnings growth stand at 18.2% and 19.7% respectively, also superior to Lockheed's result. Boeing's debt to equity ratio (although far from stellar) is twice as nice as Lockheed's. The current ratios are comparable. Boeing's dividend yield is 2.3% with a payout ratio of 31%. Both these numbers are below Lockheed's. Boeing's 787 Dreamliner has been well received, but rising fuel costs and the inevitable havoc that reeks upon the airline industry's profits has the potential to derail Boeing's current position in the market.
Other players in the defense industry, such as Raytheon (RTN), General Electric (GE), and Honeywell (HON) are no doubt concerned about the pending reductions in defense spending. The fate of these stocks are tied together in a hundred different ways and although this Gordian knot will hold for a while, it is anyone's guess how long that is.
I plan to sit on the sidelines until I see which way the congressional wind blows on the question of defense cuts. Prudence may dictate that you consider a similar course. In any event, perform your due diligence on any stock that depends on the Department of Defense for a substantial share of its revenues.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.