Sequestration Will Weigh On Lockheed’s Top Line Results

Lockheed Martin (NYSE:LMT) will announce its third quarter earnings Tuesday, October 22. The defense contractor’s top-line will likely get impacted severely from across-the-board government spending cuts called sequestration, which came in effect in March 2013. Lockheed currently estimates the full year 2013 impact on its top line from these cuts at $825 million. ^[1] This estimate is however subject to the assumption that spending reductions by the government will be achieved through delays of new program starts instead of modifying existing programs that have contractual delivery schedules. If existing programs too get modified, the estimated impact from sequestration on the company’s top-line could increase.

In the first half of 2013, Lockheed’s top-line declined by 3% annually to $22.5 billion as a result of the government’s defense spending cuts. The company currently anticipates its 2013 top-line at $44.5 billion, down from $47.2 billion in 2012. Its 2013 earnings are expected to rise to $9.20-$9.50 per share, from $8.36 per share last year, driven mainly by margin expansion due to cost reduction measures. ^{[2] [3]} It will be interesting to see if in the third quarter Lockheed can maintain its earnings growth momentum. In the first two quarters, despite a decline in top-line due to lower contract volume, the company’s profits grew on gains as a result of cost reduction measures.

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

Sequestration Will Cut In To Third Quarter’s 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 over 80% of its sales from the U.S. government including around 61% from the Department of Defense (DoD). ^[3]

Sequestration, which came into effect in 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 ended on September 30. ^[4] 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 into effect, the spending reduction over the remaining seven months (March 2013 to September 2013) of fiscal 2013 would have been higher than the figures mentioned above.

Thus, the impact from sequestration on Lockheed’s third quarter top-line could be more than what we have seen in recent results. The impact from lower government defense spending is already evident on the company’s backlog which declined by nearly 9% from the start of the year to $75.1 billion at the end of the second quarter. ^[2]

F-35 Deliveries To Partially Offset Sequestration Impact

On the bright side, the company can draw some relief from its longer cycle programs at Aeronautics and Space System segments that continue to be funded from government fiscal year 2012 and prior year budgets, and therefore do not face immediate threats from sequestration.

Additionally, Lockheed’s third quarter results will be supported by deliveries of F-35s against their undelivered backlog of 76 jets, which existed at the end of the second quarter. So far, the F-35 Joint Strike Fighter (JSF) program has not seen any major impact from government austerity as it is viewed in-line with the government’s defense priorities. In the first half of 2013, sales from the F-35 program constituted 15% of Lockheed’s total sales, and going forward we anticipate this program to occupy an even larger share of the company’s top-line to support its results amid declining defense spending from the U.S. government. ^[5]

Dividend Hikes And Share Buybacks Ease Shareholder Concerns

Separately, Lockheed has also been mindful of shareholder concerns arising from government’s defense budget cuts. Accordingly, it has focused on returning significant cash to shareholders through dividends and share buybacks. In its last related announcement on September 26, Lockheed raised its fourth quarter dividend by 16% to $1.33 per share and also hiked its share repurchase plan by $3 billion, from $1.4 billion that existed at the end of the second quarter. ^{[6] [7] [2]} Though the company does not set a time frame in which it would make share buybacks against the incremental $3 billion, it has returned significant cash to shareholders through dividends and share buybacks in the recent months. In the first half of the current year, Lockheed returned a whopping $1.7 billion to shareholders through these two channels. ^[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 Q2 2013 earnings form 8-K, July 23 2013, www.lockheedmartin.com [↩] [↩] [↩] [↩]
3. Lockheed’s 2012 10-K, February 28 2013, www.lockheedmartin.com [↩] [↩]
4. Lockheed 2013 Q1 10-Q, April 25 2013, www.lockheedmartin.com [↩]
5. Lockheed’s 2013 Q2 10-Q, July 24 2013, www.lockheedmartin.com [↩]
6. Lockheed raises quarterly dividend by 16%, September 26 2013, www.lockheedmartin.com [↩]
7. Lockheed increases share repurchase authority by $3 billion, September 26 2013, www.lockheedmartin.com [↩]