Lockheed Martin (NYSE:LMT) is scheduled to announce its second quarter earnings Tuesday, July 24. Last quarter, the company posted strong growth in revenues on a year-over-year basis driven by higher aircraft deliveries and increased production activity related to F-35 Low Rate Initial Production (LRIP) contracts. We anticipate the trend to continue in the second quarter as the company has several more production orders related to its F-35 program. However, we also anticipate the growth provided by the F-35 production contracts to be partially offset by the winding down of the F-22 program and under funded pension plan liabilities.
Overall, Lockheed Martin is likely to post good numbers for Q2 even as defense spending cuts pose a challenge to the company's growth over the next few years.
We currently have a price estimate of $95 for the company, approximately 5% above its current market price.
F-35 production orders driving growth
Sales in the aeronautics division increased by $530 million in the previous quarter on a year-over-year basis due to production activity on the F-35 LRIP contracts and increased aircraft deliveries. At the end of the first quarter, the company was yet to deliver the last three of the LRIP lot 2 aircraft, and had received production orders for 93 F-35 aircraft, of which 11 had been delivered through the end of first quarter. We anticipate deliveries against these unfulfilled production orders to drive revenue growth during the second quarter and beyond.
Growth offset by winding down of F-22 program
However, we also anticipate the lower production volume on F-22 program to continue to impact revenue growth in the second quarter. Lockheed Martin is in the process of winding down the production under the program with final deliveries to be made by the end of 2012.
Under funded pension plans to impact profits
We also anticipate the under-funded pension plans of the company to impact margins. Lockheed Martin has been hurt by low interest rates as its pension contributions to the employee pension plans have increased manifold due to liabilities associated with pension plans. The company contributed $2.3 billion and $2.2 billion in cash in 2011 and 2010, respectively, to fund its pension plans. Yet the pension plans remain underfunded, and the contributions made in the second quarter will impact its profits.
Defense spending cuts pose a challenge to long-term growth
The company's growth also faces a challenge from the looming U.S. defense spending cuts. The enactment of the Budget Control Act of 2011 will reduce defense spending by $487 billion over a 10-year period starting fiscal 2012. Lockheed Martin, which receives more than 80% of its revenues from the U.S. government, will be impacted significantly from the proposed cuts. The extent of the impact would be dependent on the extent of budget cuts. However, the company anticipates an across the board cut to reduce U.S. defense spending by $52 billion in fiscal 2013.
Share repurchase program and high dividend yield to address shareholder concerns
In anticipation of the cuts, the company has taken certain steps to address shareholder concerns. First, it approved a share repurchase program, and second, it increased the dividend payout.
Lockheed has authorization to repurchase its common stock worth up to $6.5 billion. By the end of the previous quarter, it had repurchased stock worth $3.4 billion under the program. Such a program helps prevent a large decline in stock price in the wake of a decline in revenues stemming from budgetary cuts. Also, the company recently announced its third quarter dividend of $1 per share, resulting in a high dividend yield of 4.51%. Such shareholder focused strategies help to address their concerns, which stem from the challenge posed by defense spending cuts to the company's growth over the next few years.
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