Lockheed’s Stock Looks Vulnerable With Earnings Thursday As Spending Cuts Loom

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Lockheed Martin

Lockheed Martin (NYSE:LMT) is delivering first quarter earnings on 26 April. The company posted lackluster performance in the fourth quarter of 2011 which marked the eight consecutive quarter of steady earnings with a declining income trend. Lockheed’s income slid by almost 30% in the quarter, and we expect Lockheed’s income and earnings to remain flat this quarter as the Pentagon budget cuts will be offset by company’s existing backlog which stands at a record $80.7 billion.

Lockheed Martin is the largest defense contractor in the U.S., competing with companies such as Boeing (NYSE:BA) and Raytheon (NYSE:RTN). We currently have a price estimate of $86 for Lockheed Martin, which is about 6% below the current market price.

See our full analysis for Lockheed Martin

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Cost overruns in the F-35 program

Lockheed’s flagship F-35 program with the Pentagon has run into serious cost overruns as Lockheed prepares to deliver the first installment of 63 F-35 fighter jets. Lockheed Martin is absorbing $328 million of the overrun costs while the Pentagon is absorbing remaining $672 million of the $1 billion overruns. This factor might have significant effect on the company’s profitability in the last quarter.

Pentagon spending cuts

With the Pentagon’s budget stretched due to the existing fiscal situation in U.S., Lockheed Martin will start to lose orders from its biggest customer. Approximately 85% of Lockheed Martin’s revenues originate from the federal government, making it extremely dependent to any changes in the U.S. defense spending.

Hence, current Pentagon cuts will have a significant negative effect on company’s uptake of new orders. However, over the long term, this situation will give a competitive edge to Lockheed Martin as lower Pentagon spending would mean that spending will shift from new programs to existing programs and currently Lockheed Martin has the maximum number of running contracts with the government.

International defense sales to gain prominence

With U.S. defense expenditure cooling, Lockheed Martin is staring to look towards other countries for new contracts. The company has stated that it will like to increase its share in revenues from sales outside the United States by 5%, to a total of 20% in the next two to three years. It will be interesting to see how far the company has been able to move towards this target. [1]

Pension funding to remain a matter of concern

Lockheed Martin has been hurt by low interest rates as its pension contributions to the employee pension benefit programs have increased manifold due to liabilities associated with pension plans. The company anticipated the rise in liabilities and has pumped $6B in its plan in the past three years. However, in spite of this the company’s pension fund remains underfunded, and Lockheed Martin is expected to make a contribution of $1.1B in 2012.

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Notes:
  1. Lockheed Martin eyes international sales, Security and Defense, 27 Apr-2011 []