Higher F-35 Volume, Share Buybacks Will Lift Lockheed’s Earnings Despite Weak U.S. Military Spending

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Lockheed Martin

Lockheed Martin (NYSE:LMT) will announce its fourth quarter and full year 2014 results on Tuesday, January 27. The company is coming off a good third quarter in which its profit rose on higher F-35 production volume. In the fourth quarter, we anticipate that Lockheed will continue to grow its profit as production of the F-35 fighter jet has grown. Gains from past cost cutbacks will also provide some tailwinds to Lockheed’s fourth quarter bottom line.

However, the company’s top line will likely remain under pressure from weak U.S. military spending. Lockheed generates about 80% of its revenue from U.S. government contracts, including about 60% from Department of Defense (DoD) contracts. With U.S. military spending declining due to cuts ushered in by the Budget Controls Act of 2011, Lockheed has seen its total contract volume decline during the past few years. In the first three quarters of 2014, the company’s top line contracted by a little over 2% annually due to these cuts. For full year 2014, Lockheed forecasts its top line to fall to about $45 billion, from $45.4 billion in 2013 and $47.2 billion in 2012. [1]

We currently have a price estimate of $170 for Lockheed, about 10% below its current market price.

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See our complete analysis of Lockheed here

Higher Production Volume Of F-35 Driving Growth

Despite pressure on its top line, Lockheed could report higher profit in the fourth quarter as its F-35 margins are improving. With the development of the F-35 significantly complete, the company is slashing its development workforce. During the past decade, Lockheed had raised its workforce of scientists, engineers and IT professionals to develop the F-35. However, as the program is now transitioning from the development to production phase, the company is reducing its development workforce. In addition, this decrease in the development workforce is greater than the increase in the production workforce. So, Lockheed is seeing its F-35 margins improve due to a reduced employee headcount.

In addition, as production of the F-35 is ramping up, manufacturing efficiency is improving, supporting margin expansion. In 2014, Lockheed has produced F-35s at an average rate of 3 per month, up from 0.5 per month in 2010. [2] Apart from contributing to profit growth, higher F-35 production volume is helping to temper the negative impact from the flat-to-declining U.S. military spending. The F-35 program currently constitutes about 18% of Lockheed’s total revenue, and we figure in the coming years, the program’s contribution to the company will rise with the planned ramp up in its production.

Gains From Cost Cuts Supporting Profit Growth

Separately, Lockheed is focusing on reducing its other costs. At the start of 2014, the company announced that it aims to reduce its facility footprint by 2.5 million square feet through 2015. [3] We figure this cost reduction will support growth in the company’s profit in the fourth quarter.

For full year 2014, Lockheed expects its earnings to be around $11.15 per share, up from $9.04 per share in 2013. [1] A significant portion of this anticipated increase in Lockheed’s per share earnings will come from a reduced share count, driven by the company’s active share buyback program. Through the first nine months of 2014, Lockheed bought back shares worth approximately $1.6 billion. At its third quarter earnings release, the company announced that it would reduce its outstanding share count to below 300 million over the next 3 years from roughly 315 million currently. [4] These share buybacks should help to grow the company’s per share earnings in the fourth quarter.

Additionally, at an average repurchase price of $175 per share, Lockheed’s stock buyback program will return approximately $2.6 billion to shareholders over the next 3 years. We figure this solid return of cash to shareholders through stock buybacks is helping address investor concerns arising from the flat-to-declining U.S. military spending, which accounts for a majority of Lockheed’s business.

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Notes:
  1. Lockheed’s 2014 Q3 earnings form 8-K, October 24 2014, www.lockheedmartin.com [] []
  2. Lockheed Martin Aeronautics F-35 Briefing, November 19 2014, www.lockheedmartin.com []
  3. Lockheed’s 2013 Q4 earnings transcript, January 23 2014, www.seekingalpha.com []
  4. Lockheed’s 2014 Q3 earnings transcript, October 24 2014, www.seekingalpha.com []