Lockheed Martin (LMT), the largest defense contractor in the U.S., as well as one of the largest in the world, beat earnings estimates in its second quarter earnings release reported on July 24. The company also raised its full-year outlook for EPS from a range of $7.70-$7.90 to $7.90-$8.10. The company is well known for its generous dividend policy and has a rich history of paying dividends; currently, it offers a yield of 4.4%. Before discussing the future outlook, we will analyze its historical dividend payments.
Dividend Performance Indicators
Dividend yields have been on the rise. Following shows the growth for yield rates. After getting a dip in 2006, the company has seen a back-to-back dividend growth rate of almost 20% for five years.
Also, the company raised its dividends by 33% last year, following increments of 19% and 11% in the previous two years.
OCF yields have been on a rise too (2012 is an exception). Also, FCFs have turned positive since the last two years.
It is interesting to note that the average 5-year OCF yields have been much higher than the averages of LMT's peers.
The company has successfully maintained its dividends over the last 8 years, and the payout ratio has been on a rise since 2002, as shown by the graph.
History suggests that LMT is a shareholder-friendly company. However, we need to take into account whether future circumstances will allow LMT to sustain its dividends. The most important discussion is of cash flow generation and reserves, which will eventually be used to pay off dividends.
LMT has used around $2 billion each year to buy back its shares from 2006 to 2010. Recently, the management announced that it will use $1 billion to repurchase its stock. For the first half, the repurchase activity was below expectations; however, the management, in the earnings call after the second quarter earnings release, said that they will not back off from their plan to repurchase shares worth $1 billion.
The management, when asked about the possible impact that repurchase activity will have on dividends, said that nothing can be publicly announced before the board's meeting in September to decide on dividends. During the first half, the company repurchased 4.9 million shares worth $428 million. Up till now, under the shares repurchase program, the company has used $3.6 billion to buy back 47.9 million shares, thus leaving behind the remaining authorization of $2.9 billion to be used for further repurchases.
The $308 million CAPEX for the first half of 2012 was almost down 6% YoY. The majority of the company's CAPEX relates to development facilities and infrastructure to support the new and existing programs in the business. The only comment that the management made about the CAPEX was that the company had enough cash resources to fund expansion in projects. The sell side expects the CAPEX to remain stable near the $875 million mark.
F-35, Sequestration and Margins
The F-35 project is one of the key growth drivers for the company, and will give LMT an edge over its competitors. However, due to possible sequestration in the coming years, the company will have a lot less to spend on the project. The company made 13% of its 2011 revenues from this project, which generated $6 billion. The budget cuts are expected to be worth $400 billion in the next decade, with $55 billion worth of cuts being implemented each year.
Also, the project is a fixed cost project. However, due to production issues and higher cost of inputs, the company is experiencing cost overruns. These will strain LMT's margins in the short-term.
The company enjoys revolving credit of $1.5 billion, which will expire in 2016. The facility can be enhanced by $ 500 million. The only debt maturity till 2016 is an amount of $150 million in 2013. The sell side estimates show that the debt-to-equity will fall from 75% to 38% by the end of 2014. However, this is expected to happen more because of a faster rise in capital, rather than a reduction in debt.
Peer Analysis and Conclusion
LMT is regarded as the top dividend stock in the industrials due to its high dividend yield:
What is most interesting is the 21% five-year growth rate for LMT's dividend, which is way ahead of competitors.
An overall dividend growth was witnessed in the defense/aerospace industry. Raytheon (RTN), with a dividend yield of 3.54%, deserves a special mention here. With average 5-year OCF yield being almost twice of the industry's, at 14%, we think that LMT will be able to sustain its dividends in future. Its healthy operating cash flows of $3bn can easily cover this year's total dividend of $1.3 billion.