Summary:
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Rosy future ahead of Lockheed Martin (LMT.US)
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Another multi-billion dollar contract granted by the US government
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Declining F-35 production cost may encourage partnered countries to speed up order placement
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Company raised full-year earnings guidance
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Company’s share price bounced higher after month of declines
There is no doubt that the defense is the major point of interest of the US authorities. To back words with facts let’s just say that Lockheed Martin Corp (LMT.US), the major US aircraft manufacturer, held the top position on the list of the 100 biggest federal contractors in each of the past 5 years. The company may be set to reinforce its presence at the top of the list as the US officials hinted that another stunning deal is coming soon.
Lockheed Martin managed to boost its earnings significantly since the turn of millenia. Moreover, during that period company experienced just one year of negative free cash flow (1999). Source: Bloomberg, XTB Research
F-35 fighter jets as a new growth driver
The major source of the Lockheed Martin’s revenue is its Aeronautics segment. It is this division that groups aircraft manufacturing business. The relatively recent addition to Lockheed’s offer is F-35 fighter jet. The new generation of fighter jets is said to be way more efficient than previous aircraft models and to be the most advanced (and costly) defense system at the moment. Having said that, one should not be surprised with huge demand for this type of fighter jets. Lockheed’s potential order log was abundant with over 3,100 units a year ago and may be set to keep growing as more countries are mulling purchases and Belgium recently chose F-35s over Eurofighter Typhoon fighter jets. However, out of all countries interested in acquiring new Lockheed’s planes there is one that stands out from the other - the United States. The US government is responsible for more than 75% of the aforementioned orders. As we mentioned in the introduction part of this analysis Lockheed Martin holds the position of the US top federal contractor for a couple of years now therefore it is nothing unusual to see Lockheed’s order log dominated by procurements from the US government. However, as the company faced some production and delivery delays the US commitment to the F-35 purchases at previously mentioned scale was put under question.
Aeronautics segment that includes F-35 production is Lockheed Martin’s biggest source of revenue. Source: Bloomberg, XTB Research
Major customer does not seem concerned with production delays
Various media outlets have published reports earlier this year saying that there are flaws in the F-35 production process that ultimately result in late deliveries of planes to the US military facilities. The Defence Contract Management Agency later confirmed those rumours in a statement to Bloomberg News saying that 7 out of 91 planes that were scheduled for delivery in 2018 won’t make it on time. While investors were worried whether the US government will scale down F-35 orders the Pentagon announced new contract for 141 aircrafts worth $11.5 billion. The announcement came in September and it was the biggest F-35 deal up to that date. Just 2 months later the US defense officials went on another shopping spree. Earlier this week Pentagon announced that it will award Lockheed with another contract - this time for 255 F-35s. The value of the deal was not clearly specified yet but the “not-to-exceed” threshold for this deal was set at $22.7 billion. Deliveries of aircraft ordered under this deal will begin in 2020. It is worth to mention that the US government already paid Lockheed a down-payment of $6 billion for the first 106 jet fighters under the deal. Given that this deal is likely to be recognized in the Lockheed’s financial statements over the period of at least few years, the customers’ satisfaction and the fact that only around 10% of planned purchases were delivered and majority of planned purchases was not even signed yet the whole F-35 programme is set to be boosting company’s sales and earnings during at least the next decade.
Lockheed Martin tends to receive more orders in the second half of the year. Company also holds a significant order backlog. Source: Bloomberg, XTB Research
R&D and production costs
While it all looks nice and rosy questions may surface on how Lockheed Martin financed the research and development process. Total R&D costs of the programme are estimated at $55.1 billion what is more than Lockheed’s annual revenue and more than the company earned as net profit throughout its life. The answer is pretty simple - it was not Lockheed Martin that paid the majority of the cost. The company partnered with 9 countries in the F-35 programme. The countries were ranked based on their financial and technological contribution to the R&D process. Later on, the priority to receive produced aircraft was based on this ranking. According to grades granted to each country the United States have the highest priority as the sole “Primary Customer” with the United Kingdom being the next in line as the only “Level 1 Partner”.
Another promising development concerning F-35 fighter jets is continuously declining production cost. Cost of the first two planes contracted in April 2007 were approximately $221 millions each and that figure did not include engine costs! In the latest contracts the price of a single F-35 was brought below $80 million mark (including engine). Such a significant reduction in price makes it more likely that partnered countries will speed up orders. Under such scenario the company’s already abundant order log would expand further ensuring that the company has secured enough workload in the quarters to come. While there is no clear seasonal trend in Lockheed’s orders received one can see on the chart above that orders in the third and fourth quarter often used to be larger than in the first half of the year during the past decade. Having that in mind, one can assume that one of the potentially the best quarters for the company in terms of orders is still ahead.
The main source of Lockheed’s revenue - Aeronautics segment - experienced some minor fluctuations in the operating margin throughout the past 5 year but the 10.50-11.50% range was upheld. Source: Bloomberg, XTB Research
Earnings and outlook
Lockheed Martin reported its third-quarter earnings on 23 October. The company managed to provide solid beat in all major metrics. The revenue came in at $14.318 billion, almost 10% above analysts’ median forecast. Moreover, positive surprises of around 20% were spotted in EPS and net income figures. While better-than-expected performance was reasoned with acceleration in F-35 production and execution on record backlog there were more reasons for investors to cheer. Namely, the company raised its full-year earnings guidance to $17.50 from the previous range of $16.75-17.05. On the other hand, the company released the first early revenue forecast for 2019 and it shows an expected growth of 5-6% YoY, what would be weaker result than in 2016 and 2017. Last but not least, while the outlook may change and share prices fluctuate there is another factor making Lockheed Martin a nice addition to stock portfolio - the company did not skip a single year in terms of dividend payouts since its foundation in 1995.
October 2018 was far from good for Lockheed Martin (LMT.US) investors as share price declined almost 15% in that period. Nevertheless, the stock managed to find bottom in the vicinity of $283 handle and climb back above the $300 mark later on. Bulls failed to break above the resistance zone ranging $314-316 in the first half of November but subsequent positive price reaction to the $300.50 handle makes future look promising. Source: xStation5
