Ticker:
LMT
Sector:
Industrials
Industry:
Aerospace and Defense
Recommendation: HOLD
RECOMMENDATION
Pricing
Closing Price $75.37
(10/03/09)
52-wk High
$112.31 (10/05/08)
52-wk Low
$57.41
(3/11/09)
Market Data
Market Cap
$29.85B
Trading Vol.
2.26M (3 mon avg)
Total assets
$34.788B
Total Liabilities $31.968B
Valuation
EPS
$7.52
P/E
10.01
P/Sales
.69
P/FCF
11.47
P/Book
10.62
Div Yield
3.22%
Profitability & Effectiveness
ROA
9.35%
ROE
49.45%
Profit Margin
6.94%
Oper Margin
10.92%
Analyst: Kevin Sanford
Email: ktsqmb@mail.missouri.edu
I strongly considered recommending we buy more
Lockheed Martin, but have decided it is best that we
hold. While the intrinsic valuation shows there exists
substantial margin of safety, there are too many risks
pertaining to the United States government and the
likelihood that they are going to cut back on defense
spending. Such cut backs could hurt Lockheed very
substantially; therefore buying more shares right now
would not be very prudent. I recommend we wait
until more information on defense spending (and
potential cut backs) is released before we make a
move one way or the other. We currently have 520
shares for approximately 3.5% of the portfolio.
COMPANY DESCRIPTION
Lockheed Martin was founded in 1995 by combining
the businesses of Lockheed Corporation and Martin
Marietta Corporation. Lockheed Martin is based out of
Bethesda, Maryland and employs roughly 146,000
people. They are the world’s leading weapons
manufacturer, and are involved in the research,
design, development, manufacture, integration, and
sustainment of technology systems and products.
Aside from that, they also provide a range of
management, engineering, technical, scientific, logistic,
and information services (Businessweek.com).
Lockheed operates in four business segments:
Electronic Systems, Information Systems & Global
Services, Aeronautics, and Space Systems.
Lockheed Martin has more than 300 partnerships in
75 countries. The majority of their business, however,
is with the U.S. Department of Defense and the U.S.
federal government agencies. In fact, Lockheed is the
largest provider of IT services, systems integration,
and training to the U.S. Government. The remaining
portion of Lockheed’s business is comprised of
1
international government and some commercial sales of their products, services,
and platforms.
VISUAL SALES AREA BREAKDOWN
BUSINESS SEGMENTS AND PERFORMANCE
Aeronautics (27% of sales and 29% of operating profits in FY2008): This
segment of the company is involved in the design and manufacturing of fighter jets,
transport planes, un-manned aircraft, air vehicles, and similar technologies that are
sold to the U.S. Government and its allies (Reuters). Some of this group’s major
products include the F-16 and F-22 fighter jets or the C-130 Hercules and C-5 Super
Galaxy transport planes. Net sales for this group decreased by 7% in 2008 to $11.5
billion; while operating income decreased by 3%. This was mainly because
operating profit in the Combat Aircraft area decreased by $947 million, which was
due to fewer purchases of the F-16 and F-22 fighter jets. Purchases of transport and
un-manned aircraft and services were relatively even. Moving forward, the highly
reputable “skunk works” laboratory has been focusing on un-manned aircraft,
among other projects (S&P).
Since the beginning of the year, revenues have been very flat in this area, still
accounting for roughly 27% of the company’s total. Operating profits, also, are
about the same, accounting for 30% of the total. The profit margin for the sector
thus far in year 2009 is a stout 13.3%.
2
Information Systems and Global Services (27% of sales and 22% of operating
profits in FY2008): This group’s main function is providing IT solutions for its
customers. Information Systems and Global Services saw a sales increase of 14% in
2008 to $11.6 billion; and an operating profit increase of 13% to $1.1 billion.
Overall, sales increased in all three lines of business during the year. Part of this
increase in sales/operating profit is a result of increased activity in global security
solutions (services related to national security, surveillance, etc). Some examples of
this segments programs are the FAA en route Automation Modernization program,
Joint Tactical Radio System program, and the MILSATCOM Mission Operations
Segment program (Forbes).
After the huge increase in net sales last year, it appears that the segment may be
leveling off. Sales remain at the 27% level they ended the year at, while operating
profits have dipped to 20% of the company’s total. As one might suspect, the profit
margin for this sector is a bit weaker than the other three, coming in at 8.2%.
Space Systems (19% of both sales and operating profits in FY2008): This
business segment manufactures government and commercial satellites, defensive
missile systems, and space transportation systems (Reuters). In FY2008, net sales
took a 2% dip (to $8.03 billion), while operating profit increased by 11% to $953
million. The decrease in revenues resulted from a significant drop in satellite sales
to governments; these lower revenues were mostly compensated by improved
performance in the Space Transportation Division, which led to an overall increase
in profit.
Space Systems, also is relatively flat in terms of net sales for 2009. The segment is
currently making up 18% of both net sales and operating profits. The profit margin
for this segment is a solid 10.9%.
Electronic Systems (27% of sales and 30% of operating profits in FY2008):
This group designs integrated hardware and software systems for many different
uses. There are three subgroups within the segment: “Maritime Systems and
Sensors”, “Missiles and Fire Control”, and “Platform, Training and Transportation
Systems”. “Maritime Systems and Sensors” is involved in the creation, sale, and
implementation of nautical systems, with uses ranging from missile defense to port
management. “Missiles and Fire Control” designs, sells, and implements land and air
systems for missile defense, battlefield missiles, and precious weapons. The
“Platform, Training and Transportation Systems” business integrates missionspecific systems and provides information management to governments. Sales for
this segment grew 4.3% in 2008 to $11.6 billion, while operating profit increased by
7%. Some of the main projects in this division include the Terminal High Altitude
Area Defense system, VH-71 Presidential Helicopter, the Aegis Weapons System, and
the Arrowhead fire control system for Apache helicopters (Reuters).
3
Electronic Systems has also been pretty flat in terms of revenue growth for 2009.
The segment currently makes up 28% of the company’s revenues and 32% of their
operating profits. The profit margin for this sector matches the Aeronautics sector
at 13.3%.
HISTORICAL INCOME STATEMENT SNAPSHOT
In Millions of U.S. Dollars
(except for per share items)
Revenue
Other Revenue, Total
Total Revenue
Cost of Revenue, Total
Gross Profit
Selling/General/Admin.
Expenses, Total
Research & Development
Depreciation/Amortization
Interest Expense, Net –
Operating
Interest/Investment Income –
Operating
Interest Expense(Income) –
Net Operating
Unusual Expense (Income)
Other Operating Expenses,
Total
Total Operating Expense
Operating Income
2008
2008-12-31
Period Length
12 Months
2007
2007-12-31
Period Length
12 Months
2006
2006-12-31
Period Length
12 Months
2005
2005-12-31
Period Length
12 Months
2004
2004-12-31
Period Length
12 Months
42,731.0
-42,731.0
38,082.0
4,649.0
--
41,862.0
-41,862.0
37,628.0
4,234.0
--
39,620.0
-39,620.0
36,186.0
3,434.0
--
37,213.0
-37,213.0
34,676.0
2,537.0
--
35,526.0
-35,526.0
33,378.0
2,148.0
--
----
----
----
----
----
(289.0)
(203.0)
(257.0)
(311.0)
(158.0)
--
--
--
--
--
(193.0)
0.0
(71.0)
(19.0)
(74.0)
(5.0)
(5.0)
0.0
306.0
15.0
37,600.0
5,131.0
37,335.0
4,527.0
35,850.0
3,770.0
34,360.0
2,853.0
33,541.0
1,985.0
As the Income Statement snapshot shows, Lockheed Martin has been very successful
in growing their revenues and profits each of the last five years. A lot of this growth
can be contributed to global political instability, especially in the Middle East, due
mainly to the fact that Israel is Lockheed’s primary export partner. But mainly, the
growth is due to increases in backlog orders. The recent increased defense
spending that has accompanied the Iraq and Afghan war has greatly benefited the
company. However, the infusion of a Democratic regime is a great danger to the
company’s long-term success. Especially considering President Obama has been
very public with his plans to decrease defense spending. There will be more on
risks to the company a little bit later on.
4
BACKLOG BREAKDOWN
The main founders of this company’s growth are backlog orders. Backlog orders are
a very good indicator of future sales. They totaled $80.9 billion in 2008. $80.9
billion was a new record, breaking the record set the previous year of $76.7 billion.
This means that there are another $80.9 billion in net sales that is going to come
through in the next couple of years. Backlog increased across all four business
segments in 2008.
This is just a visual to give a
further testament to how
well diversified Lockheed is
across its four business
segments. Operating
profits are very well spread
out, just like the company’s
net sales. This is a great
sign for the future, because
if there happens to be a
major setback in one of
these areas, they are strong
enough in their remaining
businesses to offset it.
One of Lockheed’s many
strengths is in their
product and sales diversity.
Profits come from all areas
of their business.
5
INDUSTRY OUTLOOK
The outlook for the Defense segment is pretty bleak. Democratic regimes typically
cut defense spending and the Obama regime appears to be no different. To add to
this, the U.S. defense budget is a purported “discretionary” budget and is very likely
to see further budget cuts due to our country’s increasing federal budget deficit.
There is further stress on the defense budget from other growing government
programs, namely the social-welfare program (S&P).
However, most of this activity will not affect Lockheed Martin until years down the
road. Defense allocations are planned several years in advance, so there will be a lag
before any reductions by the Obama administration take effect.
RELATIVE VALUATION
The three most common competitors to Lockheed Martin include: Raytheon
Company (RTN), Northrop Grummon (NOC), and Boeing (BA). Much like Lockheed,
both Raytheon and Northrop Grummon are largely focused on global security, and
rely heavily on United States Department of Defense spending. Boeing, however, is
more tilted towards the commercial aerospace side, are not as dependent on
government dollars, and thus may not provide as great of a comparative measure as
the other two companies. In my opinion, Lockheed compares very favorably.
Metric
LMT
BA
NOC
RTN
P/E
10.01
16.57
--
10.50
EPS
$7.52
$3.10
$-3.90
$4.38
EPS Growth (5
year)
27.41
33.91
--
25.13
Debt/Equity
1.35
50.64
.32
.24
Current Ratio
1.06
1.50
1.00
1.49
Gross Margin
10.17
16.65
17.85
20.20
Oper. Margin
10.92
5.61
-0.21
11.70
Profit Margin
6.94
3.59
-3.57
7.55
Sales Growth
(5 year)
6.07
3.92
5.12
5.06
6
5-YEAR STOCK PERFORMANCE COMPARISON
YEAR TO DATE STOCK PRICE COMPARISON
7
As the top chart illustrates, Lockheed Martin has consistently outperformed its
competitors along with the broader market over the past five years. This should not
come as a surprise, as Lockheed has a tremendous reputation and a strong business
model, which have combined to make them the leading weapons manufacturer in
the world. What is surprising, however, is the bottom chart. The company has
severely lagged behind the S&P as well its competition (excluding Raytheon) since
coming off the March lows. In fact, since March 8th, shares of Lockheed have risen
only 27% compared to a 48% increase from the broader market (Businessweek).
This leads me to believe that there is substantial price appreciation to come for the
company.
INTRINSIC VALUATION
I used the Warren Buffet Owner Earnings model for the intrinsic valuation. The
beta of .93 was found by taking the average from 4 different sources. The threemonth T-bill rate is .10. Historical market returns rate of 11 percent.
CAPM = .10 + .93(11-.13) = 10.23
In order to make my model a bit more conservative, I added 1.77 to get to a discount
rate of 12%. The growth rate for 2010 and 2011 was taken from combining
different analyst estimates and is a product of growing sales and backlog orders in
2008 and so far in 2009. Following 2011, I used a growth rate of 8%, which is
slightly below analyst estimates but is nowhere near past 5 years growth rates.
Later on the growth rate was cut back to 5%. I used a 3% second stage growth rate
for added conservatism, however it is very likely with office changes and continuing
global warfare that these numbers could be low. The model will be posted
separately. The valuation shows that Lockheed is very undervalued.
SENSITIVITY ANALYSIS
Discount Rates
14%
12%
10%
8%
6%
$73.06
$87.52
$110.35
$155.79
8%
$78.85
$100.51
$126.08
$180.92
10%
$91.50
$112.14
$143.00
$202.67
12%
$100.00
$122.11
$156.14
$221.50
8
RISKS TO THE COMPANY
Decreases in Government Spending
As I have already pointed out, Lockheed Martin is extremely reliant on the U.S.
Government and is therefore very susceptible to changes in defense spending.
President Obama has mentioned numerous times that he intends to cut back on our
country’s defense spending. Some of this has already come to fruition. On July 22nd,
a bill was rejected that included substantial funding to the company to produce
additional F-22 jets (Reuters). If this trend continues, it could severely affect
Lockheed’s business performance in the long run. However, because defense
spending is planned years in advance, the affects of any changes Obama makes will
not be felt for a while.
Pension Obligations
Lockheed, because nearly 100,000 of its 130,000 person workforce is supposed to
retire in the next decade, has very high pension costs. A large portion of the pension
funds are in investment accounts, and poor performance of the accounts along with
low interest rates can drastically affect the company’s earnings. The reason is the
company must supplement the existing funds to meet an obligation to their retirees
(Lockheed Martin). In 2005 the company announced the end of the pension plan to
new hires and will instead offer 401(k) plans.
CONCLUDING REMARKS
I believe Lockheed Martin is the best company in its industry. Not only does their
position as the leading weapon’s supplier in the world prove that, but so does the
relative valuation which shows comparative strength in almost all areas. However,
there is a lot of doubt concerning the industry as a whole, with the democratic
regime now in place. It appears that Lockheed is in as good of a position as any to
weather the potential storm of budget cuts and achieve continued growth for the
foreseeable future.
9
SOURCES
www.forbes.com
www.lockheedmartin.com
www.finance.google.com
www.finance.yahoo.com
S&P Net Advantage
Federal Reserve (Interest Rate Data)
www.bigcharts.marketwatch.com
www.reuters.com
www.businessweek.com
10
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