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Looking at profitability is a very important step in understanding a company. Profitability is essentially why the company exists and a key component in deciding whether to invest or to remain invested in a company. There are many metrics involved in calculating profitability, but for this article, I will look at Lockheed Martin's (LMT) earnings and earnings growth, profit margins, profitability ratios and cash flow.

Through the above-mentioned four main metrics, we will understand more about the company's profitability. And by comparing this summary to other companies in the same sector, you will be able see which has been the most profitable.

All material is sourced from Morningstar, Company webpage. and MSN Money.

Earnings and Earnings Growth

1. Earnings = Sales x Profit Margin

  • 2010 - $45.803 billion x 6.38% = $2.926 billion
  • 2011 - $46.499 billion x 5.71% = $2.655 billion

Lockheed Martin's earnings decreased from $2.926 billion in 2010 to $2.655 billion in 2011 or an decrease of 10.2%.

2. Five-year historical look at earnings growth

  • 2007 - $3.033 billion, 19.28% increase over 2006
  • 2008 - $3.217 billion, 6.07% increase
  • 2009 - $3.024 billion, 6.38% decrease
  • 2010 - $2.926 billion, 4.06% decrease
  • 2011 - $2.655 billion, 10.2% decrease

In analyzing Lockheed Martin's earnings growth over the past five years, you can see that the company's earnings have been decreasing from 2009 to 2011. Overall, the 2011 earnings are 14.23% lower than 2007.

Profit Margins

3. Gross Profit = Total Sales - Cost of Sales

In analyzing a company, gross profit is very important because it indicates how efficiently management uses labor and supplies in the production process. More specifically, it can be used to calculate gross profit margin. Here are Lockheed Martin's gross profits for the past two years:

  • 2010 - $45.803 billion - $41.967 billion = $3.836 billion
  • 2011 - $46.499 billion - $42.795 billion = $3.704 billion

4. Gross Profit Margin = Gross Income / Sales

The gross profit margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

In analyzing Lockheed Martin's gross margin over the past five years, the margin looks to have declined every year since 2008. The 5-year low was in 2011 with a margin of 7.97% while the high 5-year high was in 2008 with a margin of 10.88%. The 2011 gross profit margin is below the 5-year average of 9.33%.

  • 2007 - $4.234 billion / $41.862 billion = 10.11%
  • 2008 - $4.649 billion / $42.731 billion = 10.88%
  • 2009 - $4.224 billion / $45.189 billion = 9.34%
  • 2010 - $3.836 billion / $45.803 billion = 8.37%
  • 2011 - $3.704 billion / $46.499 billion = 7.97%

The decrease in the gross margin implies that management was less efficient in its manufacturing and distribution during the production process in 2011 compared to the 5-year average.

5. Operating income = Total Sales - Operating Expenses

The amount of profit realized from the operations of a business after taking out operating expenses - such as cost of goods sold (COGS) or wages - and depreciation. Operating income takes the gross income (revenue minus COGS) and subtracts other operating expenses, then removes depreciation. These operating expenses are costs that are incurred from operating activities and include things such as office supplies and heat and power.

  • 2010 - $4.049 billion
  • 2011 - $3.980 billion

6. Operating Margin = Operating Income / Total Sales

Operating margin is a measure of the proportion of a company's revenue that is left over after paying for variable costs of production, such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs such as interest on debt. If a company's margin is increasing, it is earning more per dollar of sales. The higher the margin, the better.

Over the past five years, Lockheed Martin's operating margin has been declining since 2008. The 2011 operating margin of 8.56% is below the 5-year average of 9.96%.

  • 2007 - $4.527 billion / $41.862 billion = 10.81%
  • 2008 - $5.049 billion / $42.731 billion = 11.81%
  • 2009 - $4.367 billion / $45.189 billion = 9.66%
  • 2010 - $4.049 billion / $45.803 billion = 8.96%
  • 2011 - $3.980 billion / $46.499 billion = 8.56%

As the operating margin has been declining over the past few years, this implies that there has been an decrease in the percentage of total sales left over after paying for variable costs of production such as wages and raw materials.

7. Net Profit Margin = Net Income / Total Sales

A ratio of profitability calculated as net income divided by revenue, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings.

Profit margin is very useful when comparing companies in similar industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage; a 20% profit margin, for example, means the company has a net income of $0.20 for each dollar of sales.

Lockheed Martin's net profit margin has shown a steady decrease since 2008. In 2008 the net profit margin was calculated at 7.53% while the 2011 net profit margin was calculated at 5.71%. The 2011 net profit margin of 5.71% is below the 5-year average of 6.71%.

  • 2007 - $3.033 billion / $41.862 billion = 7.25%
  • 2008 - $3.217 billion / $42.731 billion = 7.53%
  • 2009 - $3.024 billion / $45.189 billion = 6.69%
  • 2010 - $2.926 billion / $45.803 billion = 6.39%
  • 2011 - $2.655 billion / $46.499 billion = 5.71%

As the 2011 net profit margin of 5.71% is below the 5 year average of 6.71%, this implies that there has been an decrease in the percentage of earnings that the company is able to keep compared to the company's 5-year average.

Profitability Ratios

8. ROA - Return on Assets = Net Income / Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

Like the Profit margins listed above, the ROA has been steadily declining. The 2011 ROA of 7.00% is below the 5-year average of 6.71%.

  • 2007 - $3.033 billion / $28.926 billion = 10.49%
  • 2008 - $3.217 billion / $33.439 billion = 9.62%
  • 2009 - $3.024 billion / $35.111 billion = 8.61%
  • 2010 - $2.926 billion / $35.113 billion = 8.33%
  • 2011 - $2.655 billion / $37.908 billion = 7.00%

The 2011 ROA of 7% is below the 5-year average of 7.42%. This implies that management has been less efficient at using the company's assets to generate earnings compared to its 5-year average.

9. ROE - Return on Equity = Net Income / Shareholders' Equity

As shareholders' equity is measured as a firm's total assets minus its total liabilities, ROE reveals the amount of net income returned as a percentage of shareholders' equity. The return on equity measures a company's profitability by revealing how much profit it generates with the amount shareholders have invested.

  • 2007 - $1.500 billion / $9.805 billion = 15.92%
  • 2008 - $1.362 billion / $2.865 billion = 47.54%
  • 2009 - $1.075 billion / $4.129 billion = 26.04%
  • 2010 - $1.320 billion / $3.708 billion = 35.60%
  • 2011 - $1.706 billion / $1.001 billion = 170.42%

Lockheed Martin's ROE is erratic in that the percentage ranges from 15.92% in 2007 to 170.42% in 2011. As the 2011 ROE is very high, this reveals that the company is generating a large amount profits compared to shareholders' equity.

Cash Flows

10. Free Cash Flow = Operating Cash Flow - Capital Expenditure

A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.

It is important to note that negative free cash flow is not bad in itself. If free cash flow is negative, it could be a sign that a company is making large investments. If these investments earn a high return, the strategy has the potential to pay off in the long run.

Over the past five years, Lockheed Martin's free cash flow has remained positive.

  • 2007 - $4.241 billion - $940 million = $3.301 billion
  • 2008 - $4.421 billion - $926 million = $3.495 billion
  • 2009 - $3.173 billion - $852 million = $2.321 billion
  • 2010 - $3.547 billion - $820 million = $2.727 billion
  • 2011 - $4.253 billion - $814 million = $3.439 billion

The latest number, on the plus side, indicates that Lockheed Martin has enough cash to develop new products, make acquisitions, pay dividends and reduce debt.

11. Cash Flow Margin = Cash Flow from Operating Activities / Total Sales

The higher the percentage, the more cash available from sales.

If a company is generating a negative cash flow, it shows up as a negative number in the numerator in the cash flow margin equation. This means that even as the company is generating sales revenue, it is losing money. The company will have to borrow money or raise money through investors in order to keep on operating.

As Lockheed Martin's cash flow margin is positive, it does not have to take the above measures to continue operating.

  • 2007 - $4.241 billion / $41.862 billion = 10.13%
  • 2008 - $4.421 billion / $42.731 billion = 10.34%
  • 2009 - $3.173 billion / $45.189 billion = 7.02%
  • 2010 - $3.547 billion / $45.803 billion = 7.74%
  • 2011 - $4.253 billion / $46.499 billion = 9.14%

Summary

In analyzing Lockheed Martin's earnings growth over the past five years, you can see the earnings have been declining since 2008. Overall, the 2011 earnings are 14.23% lower than 2007.

As illustrated above and using a 5-year time frame, the listed profit margins show a decline. All the listed profit margins are below there 5 year averages.

The ROA and ROE show very different results. Like the other listed profit margin metrics listed above the ROA is showing a decline. The ROE is showing strong results over the past five years with a strong increase.

With free cash flow and the free cash flow margin both displaying positive cash, Lockheed Martin has enough cash to develop new products, make acquisitions, pay dividends and reduce debt without having to borrow or raise money to maintain operations.

The analysis of Lockheed Martin's profitability reveals a company with declining profitability margins and earnings, but positive cash and cash flow. Based on the profitability analysis above the margins and earnings are a couple of areas of the company to watch moving forward.

Source: Lockheed Martin: Profitability Analysis