Weekly Defense Note: Boeing And Lockheed Martin

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The past week saw important developments related to two defense contractors under our coverage. On Tuesday, September 24, Boeing‘s (NYSE:BA) F-15 was rejected by South Korea for a $7.7 billion fighter jet deal. [1] With this move, the contest for Korea’s fighter jet deal which at present is one of the largest defense deals worldwide has opened again for competitors that include Lockheed Martin (NYSE:LMT) and European Aeronautic & Defense & Space Company (EADS).

Prior to this rejection, Boeing’s F-15 was the only fighter jet that remained in contest after competing bids from Lockheed and EADS were rejected as they exceeded Korea’s budget. However, the F-15 was also rejected in a final review on Tuesday as it didn’t possess stealth capabilities which are sought by Korea to counter North Korea’s nuclear installations. The rejection though a setback for Boeing does not pose an immediate threat to its F-15 program as it has an order for 84 F-15s from Saudi Arabia which extends its F-15 production line through 2019.

For Lockheed, this rejection is good news as its F-35 which possesses stealth capabilities can apply when bids are invited again. During the week, Lockheed also raised its quarterly dividend by 16% to $1.33 per share and raised its share repurchase plan by $3 billion. [2] [3] These steps will return greater cash to Lockheed’s shareholders and thus ease some of their concerns arising from the negative impact from defense budget cuts in the U.S..

Boeing

Boeing was widely expected to bag the 60-jet contract from Korea after it remained as the only bid in the contest. With Korea already operating a fleet of 60 F-15s, maintenance and operational synergies were also expected to weigh in Boeing’s favor. [4] However, the rejection came following strengthening of a view in Korea’s defense and political circles that the F-15 would not create a futuristic air force capable of passing through North Korea’s radars undetected to neutralize its nuclear assets. Regional considerations also probably prompted a rethink as Japan is buying the advanced F-35s while China and Russia are developing their fifth-generation fighter jets capable of stealth. These geopolitics would support Lockheed’s F-35 in favor of Boeing’s F-15 when the contract reopens for bids in the coming months.

For Boeing, this contract from Korea would have provided enormous boost to its defense business which is facing pressure from declining defense spending in the U.S.. Defense business constitutes more than a third of Boeing’s top line and the U.S. government contributes more than 80% of the company’s defense business. In the current year, Boeing expects its defense sales to lie in a range of $31.5-$32.5 billion compared to $32.6 billion last year. [5] [6]

See our complete analysis of Boeing here

Lockheed Martin

After Boeing’s rejection, Lockheed’s F-35 is now one of the strongest contenders for Korea’s fighter jet deal. However, Lockheed will have to lower the jet’s price, which in the past has threatened support from some of its international clients. Last year, a Department of Defense report cited the F-35A’s flyaway cost at over $153 million, which would list the contract value for 60 F-35As at over $9 billion. [7] Thus, the company would have to achieve further price cuts to make a bid that meets Korea’s budget cap. Lockheed, on its part, contends that the plane’s price has come down steadily driven by cost efficiencies and it figures that the price will come further down as production rates under the program rise.

Additionally, like Boeing Lockheed also receives more than 80% of its defense sales from the U.S. government, however, unlike Boeing it does not have a growing commercial airplane business. Thus, Lockheed is more vulnerable to defense cuts from the U.S. government. In recent years, the defense contractor has focused on international sales to offset the impact from lower U.S. defense spending. The company targets to raise the proportion of sales from international customers to 20% of its total sales within the next few years and large defense contracts like Korea’s fighter jet deal will go a long way in helping it achieve the same.

Separately, on Thursday, September 26, Lockheed raised its fourth quarter dividend by 16% to $1.33 per share in likely an attempt to ease shareholder concerns arising from government austerity. The company also raised its share repurchase plan by $3 billion, however, did not indicate a time frame in which it would make these repurchases. Since the start of the year Lockheed has increasingly focused on returning cash to shareholders through dividends and share buybacks. In the first half of this year, the company returned a whopping $1.7 billion to its shareholders through these two channels and still had around $1.4 billion remaining in its share buyback program at the end of the second quarter. [8]

See our complete analysis of Lockheed Martin here

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Notes:
  1. South Korea dumps Boeing’s fighter jet, Lockheed soars back, September 24 2013, www.reuters.com []
  2. Lockheed raises quarterly dividend by 16%, September 26 2013, www.lockheedmartin.com []
  3. Lockheed increases share repurchase authority by $3 billion, September 26 2013, www.lockheedmartin.com []
  4. Republic of Korea Air Force, September 27 2013, www.wikipedia.com []
  5. Boeing’s Q2 2013 earnings form 8-K, July 24 2013, www.boeing.com []
  6. Boeing’s 2012 10-K, February 11 2013, www.boeing.com []
  7. Lockheed Martin F-35, September 27 2013, www.wikipedia.com []
  8. Lockheed’s Q2 2013 earnings form 8-K, July 23 2013, www.lockheedmartin.com []
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