Sequestration Will Cut Into Lockheed’s Top Line Results

Lockheed Martin (NYSE:LMT) will announce second quarter earnings on July 23. The defense contractor’s top line will likely get impacted severely from across-the-board government spending cuts called sequestration, which came in effect from March 1, 2013. Lockheed currently estimates the full year 2013 impact on its top line from these cuts at $825 million. ^[1] However, this estimate is subject to the assumption that spending reductions by the government will be achieved through delay of new program starts and not through modification of existing programs that have contractual delivery schedules. However, if existing programs too get modified then the estimated impact from sequestration on the company’s top line could increase. Lockheed currently anticipates its top line to be around $44.5 billion in 2013, compared to $47.2 billion in 2012. ^[1]

On the bright side, resumption in F-35 deliveries to U.S. defense forces April onward will offset in part the negative impact from sequestration in the second quarter results. It will also be interesting to see if Lockheed can maintain its earnings growth momentum in the second quarter. In the first quarter, despite a decline in the company’s top line due to lower contract volume, profits grew on margin expansion driven by cost cuts.

We currently have a stock price estimate of $95 for Lockheed, around 15% below its current market price.

See our complete analysis of Lockheed here

Sequestration Will Impact Top Line

Lockheed is highly vulnerable to spending reductions from the U.S. government as the latter constitutes a very high share of the company’s total sales. In 2012, Lockheed received around 82% of its sales from the U.S. government including around 61% from the Department of Defense (DoD). ^[2]

Sequestration, which came in effect from March, mandated an 8% annual reduction in the government’s defense budget and 5% annual reduction in its non-defense discretionary funding in fiscal 2013, which ends on September 30. ^[3] However, as government agencies had expended at fiscal 2012 levels during the first five months of fiscal 2013 – October 2012 to February 2013 – prior to the sequestration coming in effect, the spending reduction over the remaining seven months – March 2013 to September 2013 – of fiscal 2013, will be higher than the figures mentioned above. Thus, the impact from sequestration on Lockheed’s second quarter top line could be sharper than we have seen in recent results.

At the same time, the company can draw some respite from its longer cycle programs across Aeronautics and Space Systems segments that will not face an immediate impact from sequestration, as they continue to be funded from government fiscal year 2012 and prior year budgets.

Resumption In F-35 Deliveries And Lower Cost Structures Will Aid Results

In the second quarter, the impact from government austerity will also be partially offset by resumption in F-35 deliveries. During the first quarter, Lockheed had suspended deliveries of F-35s to U.S. defense forces due to two flight suspensions. Deliveries against the 88 unfilled F-35 orders, as of March 31, 2013, will lift results in the second quarter. ^[3]

Also in focus this earnings will be Lockheed’s margins. In the first quarter, despite a decline in sales, the company posted 15% annual growth in earnings to $2.33 per share on margin expansion driven by cost cuts. ^[1] Lockheed reduced its workforce, especially at its Information Systems segment, during the first quarter. Benefits from tge lower cost structures will aid profits in the second quarter. Overall, for full year 2013, Lockheed guides its earnings to lie between $8.80 per share and $9.10 per share, up from $8.36 per share in 2012. ^{[1] [2]}

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Lockheed’s first quarter earnings release, Form 8-K, April 23 2013, www.lockheedmartin.com [↩] [↩] [↩] [↩]
2. Lockheed’s 2012 10-K, February 28 2013, www.lockheedmartin.com [↩] [↩]
3. Lockheed 2013 Q1 10-Q, April 25 2013, www.lockheedmartin.com [↩] [↩]