Rising F-35 Volumes Lift Lockheed’s Results Despite Weak U.S. Military Spending

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Higher production and delivery volume of the F-35 fighter jet lifted Lockheed‘s (NYSE:LMT) fourth quarter results even as overall U.S. defense spending remains weak. The defense contractor’s revenue rose by 9% per year to $12.5 billion, and its profit improved to $904 million in the fourth quarter. This strong fourth quarter enabled Lockheed to grow its 2014 top line, against expectations and the company’s own guidance. Lockheed posted $45.6 billion in total revenue in 2014, up marginally from $45.4 billion in 2013. [1]

Importantly, Lockheed’s backlog recovered to $80.5 billion at the end of 2014, after steadily falling through the first nine months of the year. [1] We figure rising orders for the F-35 pushed up the company’s backlog, despite flat-to-declining U.S. defense spending, which constitutes about 80% of its total revenue. Lockheed’s position as the chief contractor on the F-35 program, which is considered a priority program by the government, will continue to provide support to its growth in an environment of uncertain defense spending. Lockheed also mentioned in its call that international orders constitute more than $20 billion of its backlog, representing over 25% of its year-end backlog. [2] This effectively means that international sales will constitute a higher share of Lockheed’s revenue in the coming years, reducing its dependence on the U.S. government.

Looking ahead, however, there are concerns that lower global crude oil prices could weigh on military equipment purchases by countries from the Middle East. This could temper growth in Lockheed’s international orders, impacting its strategy of reducing dependence on U.S. defense spending. Marillyn Hewson, CEO of Lockheed, however, reaffirmed on the earnings call that many countries from the Middle East have conveyed their desire to continue to buying military equipment in spite of lower oil prices.

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

See our complete analysis of Lockheed here

Rising F-35 Volume

In 2014, Lockheed delivered 36 F-35 fighter jets, producing them at an average rate of 3 per month. During the fourth quarter, Lockheed also finalized the lot 8 production (LRIP – low rate initial production) contract with the government for 43 F-35s. [2] Deliveries for this contract will be made in 2015. So, Lockheed’s F-35 production and delivery volume is set to rise in the current year.. Thereafter, in 2016 and 2017, F-35 production will significantly ramp up, crossing a run rate of 100 annual deliveries in 2018. Higher production and delivery rates will also help lower the F-35’s per unit price through improved production efficiencies. So, even as overall defense spending by the U.S. government remains weak, Lockheed’s presence on the F-35 program ensures that the company is better positioned than many other defense contractors to grow its results in the coming years.

U.S. Defense Budget Outlook For Fiscal 2016

With regard to the government’s defense budget for the fiscal year 2016, the White House will propose this budget to Congress in early February. It is expected that the proposed fiscal 2016 defense budget will be higher than the fiscal 2015 budget. However, the amount that will eventually be approved will be decided after Congressional deliberations, which will take place over the next few months. Nonetheless, the expectation that the defense budget could rise in the next fiscal year is a significant improvement from the past few years, in which the government’s defense budget steadily declined.

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Notes:
  1. Lockheed’s 2014 Q4 earnings form 8-K, January 27 2015, www.lockheedmartin.com [] []
  2. Lockheed’s 2014 Q4 earnings transcript, January 27 2015, www.seekingalpha.com [] []