Cost Cuts Could Lift Lockheed’s Earnings Despite Weak U.S. Military Spending

Lockheed Martin (NYSE:LMT) will announce its second quarter earnings Tuesday, July 22. The defense contractor is coming off an average first quarter in which its revenues fell by 4% annually, as higher F-35 sales were more than offset by lower contract volume. ^[1] We figure in the second quarter, the company will continue to face pressure on its top line from flattish defense spending of the U.S. government, which constitutes over 80% of Lockheed’s top line.

On the bright side however, we anticipate Lockheed’s second quarter profits could rise despite pressure on its top line. The company is implementing cost reduction measures, gains from which could more than offset potential decline in its top line, lifting its second quarter profits. In the previous quarter as well, despite decline in its top line, Lockheed posted 23% year-over-year growth in its earnings on gains from cost reduction measures and a reversal of pension expenses. ^[1]

Separately, we will watch Lockheed’s second quarter results for its backlog. The company started 2014 with a record backlog of $82.6 billion, but this fell considerably in the first quarter to about $79.6 billion at the end of March. ^[1] This decline is dangerous as backlog is a crucial indicator of future sales. Thus, we will be noting Lockheed’s backlog to see if it declines further or stabilizes. We currently have a stock price estimate of $164 for Lockheed, marginally above its current market price.

See our complete analysis of Lockheed here

Weak U.S. Defense Spending Is Weighing On Lockheed’s Revenues

With the U.S. government continuing to face budgetary pressures, its military spending is declining. This is weighing on Lockheed’s overall contract volume, as the company gets a majority of its contracts and revenues from the government. However, even as the company’s overall contract volume is facing pressure, its F-35 production volume is rising driven by greater budgetary allocation to this program by the government. In the second quarter, we anticipate higher production volume of F-35s to temper the negative impact from weak government military spending. Lockheed currently generates about 16-17% of its revenues from the F-35 program, so higher production volume under this program has a considerable impact on the company’s results. For full year 2014, the company anticipates its top line to fall between $44 billion and 45.5 billion, compared with $45.4 billion in 2013. ((Lockheed’s 2014 Q1 earnings form 8-K, April 26 2014, www.lockheedmartin.com))

Cost Cutbacks Could Lift Profits

Additionally, despite marginally lower expectation for its 2014 top line, Lockheed anticipates its 2014 earnings to rise by 16-20% annually to $10.50-10.80 per share on gains from cost reduction measures. ^[1] The company initiated massive cost cuts last year in response to the government’s across-the-board spending cuts, called sequestration. Though the government has eliminated these cuts in its budget for fiscal 2014, Lockheed is continuing to slash its costs in order to drive its profits higher. At the start of this year, Lockheed said that it aims to reduce its facility footprint by around 2.5 million square feet over the next two years. ^[2] The company has also employed other cost reduction measures such as headcount reductions. Margin expansion driven by these measures could expand Lockheed’s profits in the second quarter.

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