Potential South Korean Order to Expand Lockheed’s F-35 International Client Reach

South Korea recently hinted that it would purchase Lockheed’s F-35 in a multi-billion dollar deal early next year. The country’s defense ministry announced that it would place an order for 40 fighter aircraft with stealth capabilities. Though the ministry did not explicitly name the F-35, the stealth requirement leaves only this aircraft among other contenders for the deal.

We figure this order from South Korea will strengthen the already strong international interest in the F-35 program, thereby helping Lockheed (NYSE:LMT) to partially offset the negative impact from the declining U.S. defense spending on its sales. Additionally, this order will help Lockheed lower the per unit price of the F-35, thereby saving several hundreds of millions of dollars for the U.S. military.

We currently have a stock price estimate of $120 for Lockheed Martin, around 15% below its current market price.

See our complete analysis of Lockheed here

Rising International Orders For The F-35 Help Lockheed Offset Government Austerity

For Lockheed Martin, the South Korean order will help offset the impact from declining defense spending from the U.S. government. The company currently anticipates its top line to fall to around $45 billion in 2013, from $47.2 billion last year, primarily due to defense spending restrictions imposed through the Budget Controls Act of 2011 and sequestration, which came in effect from March 1 earlier this year. ^[1] Additionally, in its last earnings release, the company announced that its top line will likely continue to contract in 2014 due to the government’s defense budget cuts. ^[2]

In light of such a challenging environment in the U.S., the growing international interest in the F-35 program is helping Lockheed to counter the austerity at home. When South Korea formally announces its order for 40 F-35s next year, it will join the U.K., Italy, Norway, Netherlands, Israel, Australia and Japan in the group of countries that have placed orders for the F-35. In addition to South Korea, Turkey and Singapore will also likely place orders for the F-35 next year, while many countries in the Middle-East have also shown interest in obtaining this fifth-generation fighter jet. However, sales of the F-35 to the Middle-Eastern countries do not seem likely in the foreseeable future due to Israeli concerns. Nonetheless, in our opinion, growing orders for the F-35 from international governments reflect growing confidence in the F-35 program, which until some time back was plagued with delays and cost hikes.

South Korean Order Could Likely Lower F-35’s Cost

These growing international orders will also lower F-35’s cost as total development and production costs under the program will get distributed over a larger number of planes. The Pentagon currently expects the cost of a F-35 fighter jet to come down to around $85 million by the end of the decade, from over $100 million presently. ^[3] This will in turn save several hundreds of millions of dollars for the U.S. defense forces, which plans to purchase over 2,400 F-35s from Lockheed over the next couple of decades.

In the interim, international orders for the F-35 like the one anticipated from South Korea will help the Pentagon deal with the mandatory spending restrictions. International orders will help fill in for potential order delays caused by the spending cuts.

South Korea Focused On Buying Jets With Stealth Capability

Earlier this year in September, South Korea surprisingly re-opened its multi-billion fighter jet deal after turning down Boeing’s F-15, which remained the only bid conforming to its $7.8 billion budget limit. The country turned down the F-15 due to its fewer stealth capabilities, and we at the time had written that the F-35 would stand a good chance of getting the contract due to the revised criteria. For South Korea, stealth capability in its fighter jets is crucial to counter the threat from North Korea with which it has technically been at war at since 1953. Regional considerations including purchase of 42 F-35s by Japan and development of indigenous fifth-generation stealth fighter by China also likely played a role in South Korea’s decision to select fighter jets with radar-evading capabilities.

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

1. Lockheed’s 2012 10-K, February 28 2013, www.lockheedmartin.com [↩]
2. Lockheed’s 2013 Q3 earnings form 8-K, October 22 2013, www.lockheedmartin.com [↩]
3. South Korean order would drive down F-35 per plane cost lower, November 22 2013, www.reuters.com [↩]