Higher Margins Driven By Cost Cuts Lift Lockheed’s Profits Despite Lower Sales

Lockheed Martin‘s (NYSE:LMT) first quarter revenues fell by 4% annually to $10.7 billion, as higher F-35 sales were more than offset by lower contract volumes in the company’s other segments. However, even as revenues decreased, the company reaffirmed that it remains on track to achieve its full year revenue guidance of $44-45.5 billion, which compares to its revenues of $45.4 billion last year. ^[1]

Additionally, despite lower revenues Lockheed’s first quarter earnings soared by 23% annually to $2.87 per share on gains from cost reduction measures and reversal of pension expenses. ^[1] New rules accelerated pension payments from the government to Lockheed and other defense contractors. Earlier, even though the government paid for a portion of the pension of a defense contractor employee who worked on military programs, these payments were made with a time lag of many years. With the new rules that came in effect last year, these pension payments by the government have been accelerated boosting cash and earnings of defense contractors such as Lockheed. These accelerated pension payments coupled with gains from cost cutbacks drove growth in Lockheed’s first quarter profits. Backed by a strong performance in the quarter, the defense contractor also raised its full year 2014 earnings guidance to $10.50-10.80 per share, from 10.25-10.55 per share it announced earlier in January. ^[1]

On the flip side, new orders for Lockheed during the first quarter could not keep pace with its sales, as a result, its backlog declined to $79.6 billion at the end of the first quarter, from $82.6 billion at the start of 2014. ^[1] In our opinion, this decline in backlog is dangerous as it is a crucial indicator of the company’s future sales and earnings. Given the flat to declining defense spending environment in the U.S., Lockheed will have to increase its efforts in the international market to maintain its backlog. A potential area of growth could be international sales of the F-35. In the recent past, multi-billion dollar orders for the F-35 from South Korea and Australia have showed that there is potential international demand for this fifth generation fighter jet. More international orders for the F-35 will help support Lockheed’s backlog and its future earnings. Growth in international orders will also help Lockheed reduce its dependence on the U.S. government, which currently constitutes over 80% of its revenues.

We currently have a stock price estimate of $155 for Lockheed, around 5% below its current market price. We are in the process of incorporating first quarter results and shall update our analysis shortly.

See our complete analysis of Lockheed here

Higher F-35 Volumes & Cost Cutbacks Lift Profits

In the first quarter, Lockheed benefited from higher production volumes of its F-35 fighter jet. During the quarter, the company delivered eight of these jets to the U.S. defense forces, compared to zero deliveries in the year ago period. ^[1] Over the next couple of years, Lockheed will likely see significant growth from its F-35 program driven by growing funding from the U.S. government as well as more orders from international partners of the program. In fiscal 2014, new orders for the F-35 from the government are projected to increase by 20% from the previous year. And, in fiscal 2015, F-35 orders from the government are projected to rise by an additional 30%, from fiscal 2014. ^[2] International support for the jet is also growing, reflected by recent orders from South Korea and Australia. This growth in F-35 orders will enable Lockheed to raise its production rate for the F-35s, further growing its revenues and earnings. All in all, like in the first quarter, we anticipate the F-35 program to drive growth in Lockheed’s results in the coming quarters.

Additionally, the company’s first quarter results also gained from its cost reduction measures. Lockheed is continuing to lower its cost structures through plant consolidations and headcount reductions. In the first quarter, through these measures, Lockheed expanded its segment operating margins to 13.4%, from 10.1% in the prior year period. ^[1] Margins rose across four of the company’s five segments. The company is currently reducing its facility footprint and through 2015 aims to remove 2.5 million square feet from the same. ^[3] We figure these cost reductions will drive growth in Lockheed’s profits even as the current macro environment does not support top line growth.

Department of Defense Budget Outlook

Separately in March, the President proposed his base defense budget for fiscal 2015 at slightly under $500 billion. ^[2] This is flat with the budget for the current fiscal year. The President also proposed a $26 billion budget in addition to the base budget for growth and security initiatives. Lockheed believes that this proposed budget for the next fiscal year ensures solid funding for its portfolio of programs. Thus in our view, after a year of severe impact from sequestration, Lockheed’s results over the next couple of years will likely be under less pressure from U.S. military spending declines.

See More at Trefis | View Interactive Institutional Research (Powered by Trefis)
Get Trefis Technology

1. Lockheed’s 2014 Q1 earnings form 8-K, April 26 2014, www.lockheedmartin.com [↩] [↩] [↩] [↩] [↩] [↩]
2. Lockheed’s 2014 Q1 earnings transcript, April 26 2014, www.lockheedmartin.com [↩] [↩]
3. Lockheed’s 2013 Q4 earnings transcript, January 23 2014, www.lockheedmartin.com [↩]