Lockheed Martin (NYSE:LMT) posted better-than-expected results in its third quarter earnings. Though the defense contractor's top line fell by 4% annually to $11.3 billion due to sequestration, its earnings rose by 16% annually to $2.57 per share on margin expansion driven by cost cuts. Lockheed's backlog also recovered to nearly $79 billion after falling steadily for the past couple of quarters.
The company also guided for a lower impact on its 2013 top line from across-the-board government spending cuts called sequestration. Lockheed had earlier expected its 2013 top line to fall by $825 million annually due to these cuts, but revised that estimate significantly downward as it did not see much impact from these cuts in the first three quarters. The company's longer cycle programs remain funded from prior year budgets and therefore weren't impacted much from spending reductions introduced under sequestration. As a result, Lockheed raised its full year 2013 sales outlook to $45 billion from $44.5 billion, and its 2013 earnings guidance to $9.40-9.70 per share from $9.20-9.50 per share on better-than-expected gains from cost controlling measures.
We are in the process of incorporating Lockheed's third quarter results in our analysis and shall update our analysis shortly.
Margin Expansion Drives Lockheed's Profit Growth
In the third quarter, Lockheed continued to cut costs through multiple initiatives which included headcount reductions and temporary factory shutdowns, among others. This was done to offset the impact from sequestration which came into effect in March. As a result, the company expanded its operating margins to 11.1% in the third quarter, from 9.6% in the year-ago period. This expansion in margins raised its profits despite top line pressure from reduced defense spending by the government.
International Growth Reduces Dependence On U.S. Spending
Lockheed is especially vulnerable to a decline in the government's defense spending as it gets nearly 85% of its revenues from the U.S. government (Source:10K). During the quarter, the company made steady progress in international expansion as it seeks to reduce dependence on the government. It received the first international order for its THAAD missile defense system from the UAE. The F-35′s low rate initial production (LRIP) lot 6 and 7 contracts finalized during the quarter also consisted of a larger component for international customers with production positions for Australia, Italy, Norway and the U.K. South Korea's decision last month to not finalize Boeing's (NYSE:BA) F-15 for its multibillion dollar fighter jet contract also opened a window of opportunity for Lockheed's F-35. We figure these developments will help Lockheed expand international sales, and thus reduce the impact from declining defense spending at home. On its part, the company reaffirmed, during its earnings announcement, that it will raise the proportion of international sales in its total sales to 20% within the next few years.
Backlog Expansion Raises Future Visibility
Interestingly, Lockheed also expanded its backlog to $78.7 billion at the end of the third quarter driven by order inflows of $15 billion. Prior to this rise, the company's backlog had declined steadily from $82.3 billion at the start of 2013 to $75.1 billion at the end of the second quarter. This recovery in Lockheed's backlog was driven in part by its international growth. We figure that with Japan and Israel planning to purchase the F-35, Lockheed's international backlog could rise further in 2014.
Additionally, Lockheed said during its earnings release that it is expecting its backlog to rise to at least $80 billion by the end of 2013 (Earnings Call Transcript). This guidance provides better visibility into the company's near-term earnings outlook. Separately, the longer cycle programs in Lockheed's backlog have funding from prior year budgets which provides stability to its future earnings in the current uncertain defense spending environment.
Preliminary Outlook For 2014
In 2014, the company anticipates to retain its recent margin expansion gains and also foresees only a marginal decline in its top line from 2013. However, this outlook for 2014 assumes that no new reductions will be introduced under sequestration, the government will continue to fund Lockheed's key programs and Congress will approve the budget for fiscal 2014 in a timely manner. If, however, the government introduces new reductions in its 2014 defense budget, this outlook will likely get impacted.
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