Lockheed Martin: The Sikorsky Acquisition One Year On

Lockheed Martin (NYSE: LMT) purchased Sikorsky for close to $9 billion in November of 2015. At the time, most analysts were of the opinion that LMT had overpaid. Additionally, they believed that Sikorsky would have fit better at Textron, which manufactures Bell helicopters. Furthermore, at the time of the purchase, the helicopter market – both commercial and military sectors – was in a slump. Most people were of the opinion that Lockheed Martin had bit off more than it could chew.

As mentioned previously, the commercial and military helicopter markets have been in quite a slump over the last two years. While the low defense budget hurt demand for military helicopters, low oil prices grounded a significant portion of the commercial fleet. Helicopters are the main mode of transportation used to ferry workers from land to the oil rigs. As the oil prices began to decline, oil companies had no choice but to cut production, leading to temporary shutdown of many rigs around the world. This greatly affected the demand for commercial helicopters globally. However, as energy prices rise and Trump gets ready to boost the defense budget, it seems as though Lockheed could not have timed the Sikorsky acquisition any better.

Oil Prices Back On The Rise

Commodity markets have been on a roller coaster ride throughout 2016. At the beginning of the year, crude oil prices plummeted to multi-year lows of close to $25 per barrel due to inconsistent demand and supply mismatch of crude oil markets worldwide. The lack of demand for drilling and exploration activities led to a gradual, yet sharp, drop in the demand for rigs across the globe. To put this into perspective, the rig count, which stood at close to 1,900 in 2014 fell to just over 400 in May last year.

However, with the softness in the oil markets creating pressure on the finances of the Middle Eastern countries, the Organization of Petroleum Exporting Countries (OPEC) members decided to hold an unplanned meeting in September to revisit their stance on their rising oil production. To everyone’s surprise, the cartel announced its plans to put a ceiling on their cumulative production to reverse the decline in oil prices.

The final terms of the OPEC arrangement were announced on the 30th November, where the members decided to reduce their cumulative oil output by 1.2 million barrels of oil per day (Mbpd) over the coming months. In addition to this, the Non-OPEC members, such as Russia, also supported the OPEC’s move by offering to bring down their production by roughly 600,000 barrels of oil per day. In response to the news, crude oil prices have shot up by almost 20% over the last one month, reinforcing to investors that the commodity markets are on the path of recovery.

Going forward, this could lead to a heavy increase in demand for commercial helicopters as oil companies get ready to restart production. Regardless, falling oil prices was always going to be a temporary situation. With a reversal on the horizon, we can expect Sikorsky to see spike in commercial orders in 2017.

Trump Vows To Increase Defense Spending

Since the beginning of his campaign, President-elect Trump criticised the Obama administration for, what he believes is the weakening of the American military under Obama. Trump vehemently campaigned on a promise of greater security, particularly against terrorism. Although a huge portion of the military spending has nothing to do with terrorism, it should translate into a large spike in military spending. Furthermore, Republicans have, since Reagan, believed that defense spending is the most legitimate form of spending to stimulate the economy. We have, in his speeches, heard Trump echo similar sentiments.

In his campaign, Trump had vowed to increase defense spending to “make America great again”. He has called for almost 90,000 more soldiers, a fleet of 350 Navy ships, 100 more fighters, and strengthened nuclear and missile defenses.

Additionally, last month Congress passed the new National Defense Authorization Act, pushing about $619 billion into the Department of Defense. The bill covers the military expenditures through the beginning of the first term of Trump. It gives us a glimpse into what’s to come. It is almost a down payment on his promise to increase the size and capabilities of the military.

Most defense contractors are expected to benefit greatly from the now-evident increase in the defense spending. As a consequence, we could see higher orders at Sikorsky for its military rotorcraft going forward.

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