Slowing F-35 Deliveries Could Trim Lockheed Valuation

Lockheed Martin (NYSE:LMT) may consider slowing production of its flagship F-35 fighter jet in the wake of remarks by Vice Admiral David Venlet, the Pentagon’s F-35 program director. Highlighting the structural glitches which have plagued the program, Venlet told AOL Defense that tempering production rates may now be necessary. ^[1] His remarks draw into question Lockheed’s “concurrency strategy”, which seeks to maximize unit production before test flights are completed with a view to retrofitting any necessary repairs. If production rates are now slowed, the change in backlog could have a modest impact on our stock price valuation. Lockheed competes with companies such as Boeing (NYSE:BA).

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Concurrency Rushes Through Economies of Scale

Lockheed is the Pentagon’s number-one contractor by sales with the U.S. Department of Defense (DoD) planning to purchase more than 2,440 F-35s at a cost of $382.5 billion. In order to unleash economies of scale as quickly as possible, Lockheed’s strategy has been to ramp production early on in the program and incorporate design changes as needed during testing.

Venlet now describes this approach as a fundamental miscalculation, arguing that the cost burden of retrospectively fixing multiple design flaws on individual units is excessive. He says that while most of the glitches are minor and none of them relate to safety or performance issues, repairs are nonetheless costlier to implement post-assembly. The DoD has acted on such concerns twice before, most recently by scaling back its upcoming F-35 production batch from 42 to 30 aircraft.

Slowdown Hits Backlog, but DoD Share Growing

With the F-35 eventually expected to account for 20% of Lockheed’s revenue, any further production delays will push up the company’s aeronautics backlog and in turn reduce its earnings. Drag the trend-line below to see how a backlog of $1.43 billion by 2018 – compared with our current forecast of zero – has the effect of trimming about 3% off our Trefis price estimate of $98.

While a rising backlog is bad news for investors, any negativity should be placed in the context of the DoD’s ongoing support for Lockheed. This year the company’s aeronautics share of Total DoD, NASA and Homeland Security Contracts will reach 2.86%, and its commitment to the F-35 program should see that continue rising to 3.46% by 2014. Furthermore, 750 units of the F-35 will be sold to 11 partner countries, giving a welcome boost to Lockheed’s non-US aeronautics division.

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1. JSF’s Build And Test Was ‘Miscalculation’ Adm Venlet Says Production Must Slow, AOL Defense, Dec 1 2011 [↩]