Lockheed Martin’s $165 Fair Value Rides On Its F-35 Program & Its Growing International Sales

Lockheed Martin (NYSE:LMT) is the largest defense contractor of the U.S. government. The company’s wide product portfolio consisting of fighter jets, missiles, defense shields, combat ships and satellites positions it well to not only retain its position as the largest U.S. defense contractor but also bag a large share of the rising international military spending. In our opinion, the F-35 program and Lockheed’s rising international military sales underpin its current valuation. We currently have a stock price estimate of $165 for Lockheed, marginally below its current market price.

See our complete analysis of Lockheed here

The F-35 Program Is The Single Largest Program For Lockheed

The F-35 program currently constitutes about 17% of Lockheed’s overall revenues. With the planned ramp up in this jet’s production, we figure the F-35 program will occupy an even greater share of Lockheed’s revenues in the coming years. Lockheed plans to scale up the F-35′s production from current low rate to full scale production in the near future. The defense contractor is currently producing these jets at low rate as the program is in its initial stages with the development of the F-35 still progressing. The planned hike from low rate initial production to full scale production will help grow Lockheed’s top line, which is currently facing pressure from weak defense spending of the U.S. government. The company is highly vulnerable to this weak government spending, as it generates the majority of its sales from U.S. government contracts. Additionally, higher F-35 production will help Lockheed generate cost savings through improved production efficiencies. So, apart from lifting its top line, the planned ramp up in F-35 production will help improve Lockheed’s margins. In all, the F-35 program will likely drive a significant portion of Lockheed’s growth in the coming years. So, this program accounts for a significant portion of the company’s current valuation. The growing importance of this program was also evident from the recently announced June quarter results, in which despite weak U.S. military spending, higher F-35 production volume lifted Lockheed’s profits.

Recently, Lockheed also signed an affordability agreement with the Department of Defense (DoD). This agreement seeks to reduce the price of F-35 to under $80 million a unit by 2019. ^[1] We figure this significant reduction in F-35′s price will help generate more orders from international partners who have in the past expressed concern over the high price of this fighter jet. Till now, U.K., Norway, Netherlands, Italy, Israel, Turkey, Australia, Japan and South Korea, apart from the U.S., have placed orders/commitments for the F-35. Now, with the price of the jet certain to decline, we figure Lockheed will find it easier to meet its initial production target of around 3,000 F-35s, out of which, about 2,400 are expected to be procured by the U.S. defense forces and the remaining by international countries.

Growth In International Sales Also Underscore Lockheed’s Current Valuation

Apart from the F-35 program, Lockheed’s current valuation depends on growth in its international sales. Till a few years back, Lockheed was generating over 85% of its revenues from the U.S. government. But that percentage has steadily declined in recent years as the company began to focus on international markets in response to the flat-to-declining defense spending of the government. Lockheed currently targets to generate at least 20% of its overall revenues from international sales within the next few years. And, we figure this will be achieved as international orders already constitute about 25% of Lockheed’s backlog.

International sales are a big growth opportunity for Lockheed as military spending from many regions of the world especially the Middle-East and Asia is rising. There’s no doubt that Lockheed faces tough competition from other international military equipment makers such as BAE Systems, Airbus and Finmeccanica in growing its international sales. Some of these international defense equipment manufacturers are also not as constrained as Lockheed is by the U.S. government on technology transfer and other aspects that help win defense contracts. Nonetheless, we figure Lockheed with its advanced and wide product portfolio will be able to grow its international sales benefiting from rising international military spending.

The products of Lockheed which are currently in high demand from many countries include missile defense systems, command & control systems and littoral combat ship (LCS). And, we figure in the coming years, these products will play a key role in growing Lockheed’s international sales, which are currently driven by the F-16 fighter jet and C-130J strategic airlift aircraft.

Overall, growing international sales and planned ramp-up in F-35 production will play a key role in countering the impact from weak U.S. defense spending in the coming years. Thus, these two factors underpin Lockheed’s current valuation.

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1. Lockheed’s 2014 Q2 earnings transcript, July 22 2014, www.seekingalpha.com [↩]