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Investment Overview for Lockheed Martin (NYSE:LMT)

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Lockheed Martin Delivered Robust Earnings Even During Crisis

• Despite the impact of coronavirus pandemic on the company’s supply chain, the second quarter revenues increased by 12% to $16.2 billion coupled with a 14% growth in earnings. Along with robust earnings, the company received $22 billion of new orders and its order backlog surged by $7 billion.

• While the pandemic caused a sequential deceleration in production rate, the company delivered 22 F-35s, 5 C-130Js, and 18 helicopters during the second quarter. Also, the $22 billion of new orders were primarily driven by the $7 billion order bookings for F-35s.

• The company’s Missiles and Fire Control division also observed a double-digit growth, assisted higher deliveries of PAC-3 missiles (Patriot Advanced Capability-3) and THAAD systems (Terminal High Altitude Area Defense). Moreover, the segment’s order book got a $6 billion boost from the Defense Department requirement of additional PAC-3 MSE interceptors, and associated equipment for the U.S. military and other foreign customers.

• The second-quarter net income swelled by 14% to $1.6 billion, driven by strong revenue growth and stable margins. On a per-share basis, the growth was comparable as the company repurchased just 0.7 million shares for $259 million. However, the company paid $671 million in dividends at $2.4 per share.

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Below are the key drivers of Lockheed Martin’s value that present opportunities for upside or downside to the Trefis price estimate:

Aeronautics

• Aeronautics EBITDA Margin: EBITDA margin for the Aeronautics division stood at 15.3% in 2010 before rising to 15.7% in 2011 and then declining to 15.4% in 2012. The figure rose marginally in 2013 before falling again in 2016, to 12.8%. In 2017, the figure came in at 8%.
  In 2018 the figure came in at 15.5%
  These changes reflect the life cycles of the division’s various programs, including the F-35 and F-22 programs. We expect margins to remain level in the near term as a result of the recent ramp-up in F-35 production.
  However, if margins fall to 12% due to tighter price negotiations from the Pentagon, there could be a downside of 10% to ${trefisprice}.

U.S. Mission Systems and Training

• Mission Systems and Training Revenues: Revenues have grown modestly from $2.89 billion to $5.3 billion from 2010 to 2014. However, in 2015, the division absorbed Sikorsky, and revenues reached $6.9 billion. In 2016, the figure jumped to $9.1 billion. Revenues hit about $9.8 billion on increased orders and a pre-existent backlog at Sikorsky in 2017.
  Revenues jumped to $14.3 billion in 2018.
  If revenues rise to about $18 billion over the Trefis forecast period, there could be an upside of about 10% to ${trefisprice}.

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Missile and Fire Control Systems came in $8.9 billion in 2018. We expect that number to rise by anywhere from 10-15% in 2019, as the Federal Government continues to allocate funds to the development of missiles, and increases order flow.

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Capable missile defense systems

With the growing threat of attack from airborne missiles, missile defense systems are in demand from governments of many countries including the U.S. Lockheed possesses multiple, highly capable and efficient missile defense systems which include the Aegis, Patriot Advanced Capability-3 (PAC-3) and Terminal High Altitude Area Defense (THAAD). Sales of these systems will likely bring significant contracts and revenues to the company in the coming years.

Chief contractor for the F-35 program

The F-35 is a multi-role combat aircraft being developed by Lockheed Martin. The aircraft is part of the Joint Strike Fighter (JSF) program, intended to replace a wide range of existing combat aircraft in the U.S., the U.K., Canada, and other countries. The F-35 is a crucial program for Lockheed Martin and constituted around 22% of its top line in 2015. Over the coming years, the program is expected to occupy an even larger share in the company’s top line, driven by its planned production ramp-up. Overall, the U.S. government plans to purchase over 2,400 F-35s, while international governments are expected to purchase another 600 F-35s.

Looking ahead, as the production of the F-35 rises in the coming years, this program will drive a significant portion of Lockheed’s value.

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Increase in fixed price contracts

With a 2009 directive by the Office of Management and Budget (OMB) to further migrate from cost-based to fixed-price based contracts, we expect the company’s divisions to be subjected to higher risk. This is because any cost overruns would directly impact margins under a fixed-price contract (unlike a cost-reimbursement contract, where the contractor is paid for all of its allowed expenses to a set limit plus additional payment to allow for a profit). This trend can significantly impact Lockheed Martin’s EBITDA margins in future years.

High reliance on the U.S. government

About 94% of Lockheed’s revenue comes from the U.S. government through its agencies such as the Department of Defense, Homeland Security, and NASA. As a result of this high reliance on government spending, Lockheed is highly vulnerable to spending cuts from the U.S. government.

In 2011, the passage of the Budget Control Act required defense spending to be slashed by around $500 billion over 2011-2021. These cuts forced the government to slash its defense spending during 2011-2015 steadily. In turn, lower government defense spending decreased overall contract volume for Lockheed. However, looking ahead, with fiscal deficit improving, the government has begun to grow its defense spending. This recovery in U.S. defense spending will likely help increase Lockheed’s contract volume and its top line in the coming years.

High emphasis on cyber security

With increasing sophistication and growth in cyber attacks in recent years, IT security challenges are mounting for the U.S. government, which include cyber threats from foreign nations and terrorist organizations as well as virus/malware intrusions. We expect this trend to drive increased strengthening of the Federal IT infrastructure. This will likely maintain the demand for information systems services. Lockheed is one of the key providers of cybersecurity solutions.

How Does Trefis Modelling Work?

How do we get the historical numbers for this chart?

Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.

Who came up with the Trefis forecast for future years?

The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.

How does my dragging the trendline on the chart impact the stock price?

1. We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
2. We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.

See more on: DCF Methodology

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