Lockheed’s F-35s Could Escape Budget Cuts Next Year

The F-35 Joint Strike Fighter and the KC-46 aerial refueling tanker programs may escape from the automatic spending cuts called sequestration next year, according to the Air Force officials. Eric Fanning, the U.S. Secretary of the Air Force said “I expect we’ll get flexibility”, referring to the next year’s budget allocation for these top programs that are seen in line with the government’s defense priorities.

This is good news for Lockheed Martin (NYSE:LMT), which is the chief contractor for F-35s, and is depending on the scale up in their production rate in the coming years, to counter the impact from reduced government defense spending on its smaller defense programs. United Technologies‘ (NYSE:UTX) Pratt & Whitney, which supplies the engine for this fighter jet, and Boeing (NYSE:BA), which is leading the aerial tanker program, will also welcome this indication that plans to safeguard the government’s spending on these programs.

We currently have a stock price estimate of $101 for Lockheed, around 20% below its current market price.

See our complete analysis of Lockheed here

F-35 Program Is Crucial For Lockheed Amid Lower Defense Spending

Lockheed Martin receives more than 80% of its sales from the U.S. government, including around 60% from the Department of Defense (DoD). This high dependence makes the defense contractor highly vulnerable to any spending reductions from the government. Since 2011, the U.S. government’s defense budget has declined steadily due to the enactment of the Budget Controls Act, which slashed the government’s defense spending by around $500 billion over 2011-2021. In March, earlier this year, additional reductions to the government’s defense budget were introduced under automatic spending cuts called sequestration.

This austerity has impacted Lockheed significantly, particularly its smaller defense programs in the information technology segment. Reflecting the impact from budget cuts, the company forecasts its top line to lie around $44.5 billion in 2013, down from $47.2 billion last year. ^[1] The impact from lower U.S. defense spending is also evident on Lockheed’s backlog, which declined by nearly 9% in the first six months of 2013 to $75.1 billion at the end of the second quarter. ^[2]

In light of such an environment, a move that protects the F-35 program – which constituted 14% of Lockheed’s revenues last year – from the government’s spending cuts, will go a long way in supporting the company’s earnings.

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1. Lockheed’s 2012 10-K, February 28 2013, www.lockheedmartin.com [↩]
2. Lockheed’s Q2 2013 earnings form 8-K, July 23 2013, www.lockheedmartin.com [↩]