Ramp Up In F-35 Production & Rising International Sales Will Help Return Lockheed’s Top Line To Growth Trajectory After 2014

Lockheed Martin‘s (NYSE:LMT) top line rose steadily from $44 billion in 2009 to $47.2 billion in 2012, but fell sharply to $45.4 billion in 2013 due to the negative impact from across-the-board government spending cuts, called sequestration. ^[1] In the current year, the company anticipates its top line will decline further to around $44.8 billion, at the mid-point of its revenue forecast range. ^[2] However, as Lockheed Martin started 2014 with a record backlog of $82.6 billion, we figure it is possible for the company to return its top line to growth trajectory 2015 onward. ^[3] Given that nearly a quarter of Lockheed’s current backlog is comprised of international orders, which will likely rise in the coming years driven by rising military spending from the Middle-East and Asia, we figure the chances of Lockheed’s top line returning to growth after 2014 are significant. ^[4] The planned ramp up in the company’s F-35 production will also support growth in its top line. At the same time, the threat from sequestration remains for fiscal 2016 and beyond unless the Congress replaces them with a less severe mechanism.

We currently have a stock price estimate of $164 for Lockheed, approximately in-line with its current market price.

See our complete analysis of Lockheed here

In the near term, we figure Lockheed’s high current backlog will provide resilience to its top line, especially as the U.S. government’s defense spending is likely to remain flat or decline marginally through this decade. Lockheed is highly dependent on the U.S. government as it gets more than 80% of its revenues from the government including around 60% from the Department of Defense (DoD). So, any major dips in the government’s spending like the one last year caused by sequestration will weigh on Lockheed’s results. Additionally, the defense spending environment in the U.S. has improved drastically from last year. The government has eliminated sequestration in its budgets for fiscals 2014 and 2015. 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 growth in Lockheed’s top line.

Hike In The F-35 Production Rate Will Help Lift Lockheed’s Top Line

Apart from an improved near term defense spending environment, we figure the biggest growth drivers for Lockheed’s top line growth will be the planned hike in its F-35 production and rising international military sales of the company.

In its F-35 program, Lockheed has come a long way from the production delays and cost overruns that were experienced in this program’s initial phases. The development of the F-35 is now on track with completion expected in 2019. Recent low rate initial production (LRIP) contracts of the F-35 have also seen the per unit price of the jet come down. At a recent conference, Lockheed’s CEO Marillyn Hewson said that the price of F-35 in the most recent lot 7 LRIP production contract was 55% lower than its price in the lot 1 production contract. ^[5] Negotiations are currently on for the lot 8 LRIP contract and the Pentagon and Lockheed expect F-35’s price to fall to around $85 million a unit by the end of this decade. ^[6] These price reductions are being achieved through cost efficiencies generated by rising production volumes under the program. At the same time, growing international orders for the jet have also allowed its fixed costs to be spread over a larger number of units, thus, lowering the per unit price. In the coming years, with the planned ramp up in F-35’s production from low rate initial production to full scale production, cost efficiencies will likely further improve. From the perspective of Lockheed’s top line, this planned ramp up in F-35 production will support growth. Additionally, as the F-35 program constituted a significant 16% of the company’s top line last year, the planned ramp up in its production will drive considerable growth in the company’s top line in the coming years. ^[1]

In all, Lockheed anticipates to produce over 3,000 F-35s over the next two to three decades. And, we figure this number is achievable given the growing international interest in the program. U.S. defense forces are expected to order around 2,400 F-35s, while other countries are expected to order the rest. Recently, South Korea said that it would buy 40 F-35s in a deal valued at approximately $6.8 billion. The country joined the U.K., Norway, Netherlands, Italy, Israel, Turkey, Australia and Japan in the group of countries, apart from the U.S., that have ordered the F-35.

Growing International Military Spending Will Likely Also Lift Lockheed’s Top Line

Apart from the F-35 program, Lockheed is also seeing strong international interest in its missile defense and command & control systems, among others. The company’s missile defense systems such as the Patriot Advanced Capability-3 (PAC-3) and Terminal High Altitude Area Defense (THAAD) are evoking strong interest from many countries in the Middle-East and Europe. Given the rising military spending from some of these regions particularly the Middle-East, Lockheed’s international sales will likely grow in the coming years. So, rising international sales will also help lift the company’s top line.

Separately, Lockheed’s rising international sales will also reduce its dependence on the U.S. government. So, in the coming years, Lockheed will likely be less vulnerable to sudden declines in the U.S. government’s defense spending. The company currently plans to raise the percentage of international sales in its top line to 20% within the next few years. We figure Lockheed will be able to achieve this target as international orders already constitute around 25% of its backlog.

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1. Lockheed’s 2013 10-K, February 14 2014, www.lockheedmartin.com [↩] [↩] [↩]
2. Lockheed’s 2014 Q1 earnings form 8-K, April 26 2014, www.lockheedmartin.com [↩]
3. Lockheed’s 2013 Q4 earnings form 8-K, January 23 2014, www.lockheedmartin.com [↩]
4. Lockheed’s 2013 Q4 earnings transcript, January 23 2014, www.lockheedmartin.com [↩]
5. Lockheed at Sanford C. Bernstein conference, May 29 2014, www.lockheedmartin.com [↩]
6. South Korean order would drive down F-35 per plane cost lower, November 22 2013, www.reuters.com [↩]