Lockheed’s Shareholders Have A Lot Riding On The F-35 Program’s Success

Lockheed Martin won the The System Development and Demonstration (SDD) contract for the F-35 program in October 2001. Since then however the program been plagued by countless design issues and production delays. Development, production and maintenance costs under the program have escalated significantly, and the program has undergone three major financial restructurings since its inception. Some estimates propose that the development and procurement of 2,443 F-35s by the U.S. will reach $323 billion and total lifetime costs of the project over a 50-year life will reach an estimated at $1.51 trillion, or $618 million per plane. ^[1] This would make the program by far the costliest ever among other major defense programs in U.S. history.

The success of this program is vital for Lockheed Martin given the size of the contract and the value it holds for Lockheed. We currently have a stock price estimate of $97 for the company, approximately 5% above its current market price.

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To date Lockheed has produced 63 F-35s with limited capability meant for training purposes only under the Low Rate Initial Production (LRIP) contracts with the Pentagon. However, the company continues to face design challenges leading to production delays, which is threatening to contribute to the cost overruns. In the past few years, this has been a heated issue with the Pentagon, which recently refused to approve a comprehensive operational testing plan for the F-35 and is holding production permission for the fifth batch of F-35s under the LRIP contract until it verifies the cost data. ^[2]

Helmet-mounted display issues

The F-35 pilot helmet is supposed to enable the pilot to view all important information regarding the position of targets including nearby aircraft on the helmet visor rather than the mounted head-up display in current fighter jets. However, the helmet display is currently not operationally. It has issues with night vision, delays in displaying data, errors in alignment and jitters in certain conditions. This delay and uncertainty has forced Lockheed to bring in BAE Systems to work on an alternate helmet in case VSI is unable to provide a fully functional helmet on time. However, it is unlikely that the helmet will  be tested and operation ready prior to 2015. ^[3]

The fifth batch of F-35 LRIP contract

Also, negotiations between Lockheed and the Pentagon for production of the fifth batch of F-35 under LRIP contract have dragged on for over nine months. The Pentagon under pressure from U.S. legislators to cut its spending is insisting on detailed cost data under the program, and Lockheed Martin has yet to submit this information.

All in all, the F-35 program is one of the biggest drivers to Lockheed’s future value in our estimates, and for the company to protect its profit margins under the program, it needs to resolve outstanding design issues quickly to avoid further production delays and further cost overruns especially as political scrutiny intensifies.

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1. Lockheed Martin F-35 program cost increases and further delays, www.wikipedia.org [↩]
2. UPDATE 1-More problems raised at Pentagon F-35 fighter review, September 11 2012, www.reuters.in [↩]
3. Pentagon tells Lockheed to shape up on F-35 fighter, September 17 2012, news.yahoo.com [↩]