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Lockheed Martin (LMT)

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POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

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 estimate the margins to remain at similar level in the near term as a result of the ramp up of F-35 production in the recent past.
    However, if margins fall to about 12% due to severe price negotiations from the Pentagon, then there could be a downside of around 10% to Trefis price estimate for Lockheed Martin's stock.

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 Trefis price estimate for Lockheed Martin's stock.

BUSINESS SUMMARY

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.

SOURCES OF VALUE

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 sales 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., 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 production of the F-35 rises in the coming years, this program will drive a significant portion of Lockheed's value.

KEY TRENDS

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, as any cost over-runs 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 steadily slash its defense spending during 2011-2015. In turn, lower government defense spending decreased overall contract volume for Lockheed. However, looking ahead, with improved fiscal deficit, the government has begun to grow its defense spending. This recovery in U.S. defense spending will likely help grow Lockheed's contract volume and its top line in the coming years.

We expect the Trump administration to spend close to $700 billion on defense in 2019.

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 demand for information systems services. Lockheed is one of the key providers of cyber security solutions.

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