What Are Lockheed Martin’s Two Biggest Growth Opportunities?

Lockheed Martin‘s (NYSE:LMT) 2013 top line fell by 4% annually to $45.4 billion due to the U.S. government’s across-the-board spending cuts, called sequestration. ^[1] In the current year, due to flat defense spending from the government, the company anticipates its top line will decline further to about $44.8 billion, at the mid-point of its revenue forecast range. ^[2] Now, in our opinion, the U.S. defense spending will likely continue to remain weak through this decade due to budgetary pressures. The Budget Controls Act of 2011 requires defense spending cuts totaling $500 billion over a ten year period that began in 2012. So, Lockheed, which generates more than 80% of its revenues from government contracts, will likely be challenged in driving its growth. In such a tough environment, what are Lockheed’s two biggest growth opportunities? We figure ramp up in the F-35 fighter jet’s production and international sales are the two biggest growth opportunities for Lockheed in the coming years.

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

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

The F-35 program, which is Lockheed’s single largest program constituting around 16% of its overall revenues, is currently producing fighter jets at a low rate. This is so because the program is in its initial stages with the development of the F-35 still progressing. However, in the coming years, the company plans to scale up F-35’s production to full rate. We figure this will help return Lockheed’s top line to growth trajectory after 2014. This hike from low rate initial production to full scale production will also help Lockheed generate cost savings through improved production efficiencies. So, apart from lifting its top line, this planned ramp up in the F-35’s production will also help improve Lockheed’s margins.

Additionally, the F-35’s development is on track with completion expected in 2019. The company will likely also get to produce around 3,000 F-35s, in-line with the initial plan, as the U.S. government has on many occasions said that it will buy its promised share of about 2,400 F-35s and international orders for the jet are continuing to flow in.

International Sales Also Present A Big Growth Opportunity For Lockheed

Rising international sales, including those for the F-35, is the second big growth opportunity for Lockheed, in our opinion. Till a few years back, Lockheed was generating more than 85% of its revenues from the U.S. government. But that percentage has steadily come down in recent years as Lockheed began to focus on the international market in response to the flat-to-declining defense spending from the U.S. government. The company currently targets to generate 20% of its overall revenues from the international market within the next few years. And, we figure this figure is achievable as international orders already constitute around 25% of the company’s backlog. ^[3]

Recently, South Korea said that it would buy 40 F-35s in a deal valued at approximately $6.8 billion. Post this announcement, 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 placed orders for the F-35. Many other countries, notably those from the Middle East including Saudi Arabia and the UAE have also shown an interest in acquiring the F-35. However, in our opinion, sales of this advanced jet to these countries do not look feasible in the near term due to Israeli concerns. Overall, Lockheed anticipates to sell about 600 F-35s to international buyers, and we figure this number is achievable given the high international interest in this program. Apart from the F-35 program, Lockheed is also seeing strong international demand for some of its other products such as missile defense systems, command & control systems and littoral combat ship (LCS). Growth from these products will help grow Lockheed’s international sales which are currently being driven by the F-16 fighter jet, C-130J strategic airlift aircraft, and certain missiles and missile defense systems.

However, many challenges face Lockheed in its attempt to grow its international sales. The company has to contend with U.S. government stipulations which require prior permissions before export of defense equipment. The government has in the past placed restrictions on export of some of Lockheed’s highly advanced products such as the F-22 Raptor. Lockheed’s international sales are also affected by the purchasing government’s relationship with the U.S.. Many countries such as China that are not U.S. allies are restricted from the export of sophisticated military equipment. So, even though China is the second biggest defense spender after the U.S., and many of Lockheed’s defense products are likely desired by Chinese defense forces, Lockheed cannot export its advanced defense products to the country. Additionally, Lockheed competes with many international defense equipment manufacturers, such as BAE Systems, Airbus and Finmeccanica, some of who are not as intensely restricted by their governments as Lockheed on technology transfer. Such companies hold a competitive advantage over Lockheed if the purchasing country insists on technology transfer while awarding a contract. These challenges however, in our opinion, will shave-off only a small portion of Lockheed’s potential international military sales. So, despite these challenges, we figure Lockheed will be able to grow its international sales in the coming years driven by its advanced and wide portfolio that will capitalize on the rising military spending from many countries especially those from the Middle-East.

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1. Lockheed’s 2013 10-K, February 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 transcript, January 23 2014, www.lockheedmartin.com [↩]