Cost Cutting & A Better Defense Spending Environment Will Likely Boost Lockheed’s Earnings

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Lockheed Martin (NYSE:LMT) will announce its first quarter earnings Tuesday, April 22. The defense contractor is coming off a very challenging 2013 in which the U.S. government’s lower defense spending slashed nearly 4% from its top line. But, the company managed to grow its 2013 earnings by 8% annually to $9.04 per share on gains from cost reduction measures. [1] We figure in the first quarter, Lockheed will continue to benefit from its cost cutbacks.

Additionally, the defense spending environment in the U.S. has improved since the end of 2013. This is good news for Lockheed as it gets over 80% of its revenues from the U.S. government including around 60% from the Department of Defense. The government in its budget for fiscal 2014 has eliminated the across-the-board spending cuts, called sequestrations. Instead, it has increased limits on discretionary spending in line with the Bipartisan Budget Act, which was passed in December last year. This act provides for additional defense funding of approximately $22 billion and $9 billion for fiscals 2014 and 2015, respectively, according to figures reported by Lockheed. [1] We figure this additional funding along with greater flexibility for government agencies in allocating these funds will aid Lockheed’s results in the first quarter and the remaining months of 2014.

In all, backed by lower cost structures and better funding environment, we anticipate Lockheed to post healthy growth in its profits in the first quarter. For full year 2014, Lockheed guides its profits to rise by around 13-17% annually to $10.25-10.55 per share. [2] We currently have a stock price estimate of $155 for Lockheed, marginally below its current market price.

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See our complete analysis of Lockheed here

Cost Cutbacks Will Likely Expand Margins & Aid Profit Growth In The First Quarter

Throughout 2013, Lockheed undertook multiple cost reduction measures, which included headcount reductions and plant consolidations. The company eliminated 2.1 million square feet from its facility space through plant consolidations. [3] Savings from these measures enabled Lockheed to expand its 2013 operating margin by 50 basis points annually to 9.9%. [2]

Additionally, in its last earnings announcement, Lockheed said that it will close down more facilities in a bid to further clamp down on costs. Overall, through mid 2015, the company plans to eliminate another 2.5 million square feet from its facility footprint. [3] Thus, as these cost reduction measures remain underway, we figure the company’s margins will likely expand further in the first quarter to drive growth in its profits.

Higher Backlog Will Likely Also Provide Support To Results

Additionally, Lockheed has started 2014 with a record backlog. Driven by order inflows in the fourth quarter (of last year), the company’s backlog soared to $82.6 billion at the end of 2013. We figure this higher backlog will also support Lockheed’s results in the first quarter. [2]

More importantly, around 25% of this backlog is composed of international orders, which over the long term will help Lockheed reduce its dependence on the U.S. government. [3] Currently, the company’s high degree of dependence on the government makes it highly vulnerable to sudden declines in government spending like the one last year caused by sequestration. Thus, from a long term perspective, this relatively higher share of international orders in Lockheed’s backlog will help reduce its vulnerability to declines in the U.S. government’s defense spending.

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Notes:
  1. Lockheed’s 2013 10-K, February 14 2014, www.lockheedmartin.com [] []
  2. Lockheed’s 2013 Q4 earnings form 8-K, January 23 2014, www.lockheedmartin.com [] [] []
  3. Lockheed’s 2013 Q4 earnings transcript, January 23 2014, www.lockheedmartin.com [] [] []