Lockheed Martin (NYSE:LMT) delivered strong first quarter results driven by increased aircraft deliveries and improved operating margin for its electronics division. It is going through a favorable phase of its contracts with the federal government and is looking good with the execution. However, certain fundamental risks to the business like spending cuts from Pentagon, the curtailment of existing programs, and unfunded pension liabilities remain. Lockheed Martin is the largest defense contractor in the U.S. competing with Boeing (NYSE:BA) and Raytheon (NYSE:RTN). We have a price estimate of $86 for Lockheed Martin, which is about 6% below the current market price.
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Aeronautics division posts improved revenue and profits
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The aeronautics division of Lockheed Martin posted revenue gains of 18% as the aircraft deliveries of C-130J aircraft, F-16 jets and C-5M aircraft increased. The company delivered 10 C-130J aircraft, 13 F-16 jets and 1 C-5M aircraft last quarter as compared to six, five and none, respectively, in the prior year quarter. Revenues were slightly held back though due to lower volumes on the F-22 program, whose production is winding down, and lower activity on the F-35 systems development and demonstration contract.
The operating margins for the division stayed flat. Profit, however, jumped by 17% due to higher production volumes and increased aircraft deliveries. The negative factors were the decrease in risk retirement levels for the F-22 production program and lower production volume on the F-35 SDD contract.
Lockheed’s aeronautics division looks set for a brighter future as it has enough contracts to keep its hands full presently, and good execution will be key.
Strong expansion in electronics systems margin
Profit for the electronics systems division jumped by 25% in spite of a modest 4% increase in sales. This growth was primarily driven by an increase in risk retirements on select ship and aviation programs, tactical missile programs and fire control systems. The operating margin of this division went up from 12.4% to 15% last quarter.
Risks to certain federal programs remain
The reduced Pentagon spending on defense can curtail future revenue sources for the company. Last quarter, Lockheed saw a 4% sequential drop in its backlog. Since almost 85% of the company’s revenues come from the U.S. Federal government, it is extremely vulnerable to cost-cutting initiatives or a potential deferral of rewards by the government. Any further budgetary cuts or terminations and reductions in expenditure due to a change in priorities of Congress or the administration remain potential risk factors.
The company’s joint F-35 program with Pentagon has run into cost overruns of over $1 billion, giving rise to speculation about the government cutting the contract quantity. Such an event could negatively impact the company’s financial health.