Lockheed Martin
Beyond the F-35: Deep Dive to USA's defense gem
Reading time: ~25 minutes
Too long; Didn’t read:
Lockheed Martin is currently attractively priced and may offer a return of around 8% despite its low growth and the conservative assumptions taken.
The company has a high and sustainable Return on Invested Captial, protected by strong barriers to entry (switching costs, proprietary technology, high capital investments required).
Debt is higher than ideal but is sustainable with current earnings.
Dividend yield is currently 2.7% and the company constantly reduces its share count as an additional source of shareholder remuneration.
Valuation is not very challenging, with a PE ratio of 16x, EV/EBITDA of 12.5x and current earnings reflecting around 60% of the value.
Contents of this article:
Key Facts - Summary
Business Overview
Fundamentals
Capital Allocation
Governance
Industry & Competitors
Valuation
Risks
Conclusions
1. Key Facts - Summary
Description
Lockheed Martin Corporation (LMT) is a global leader in aerospace and defense technologies. They develop and manufacture a wide range of defense products and services, primarily serving the US government, but also several other countries internationally. The company operates through four segments: Aeronautics, Missiles and Fire Control (MFC), Rotary and Mission Systems (RMS), and Space. Their products include the widely known 5th generation fighter jet F-35, satellites, missile defense systems, and helicopters. Founded in 1912, Lockheed Martin is headquartered in Bethesda, Maryland, and is a key player in government programs and major defense projects.
Fundamentals
Profitability: In the last 20 years, LMT had an average Return on Capital Employed of 22.2%, well above its Cost of Capital. Since 2011, ROCE has fluctuated between 15% and 28% but has remained quite stable.
Margins: LMT’s operating margin is very stable and has averaged 12.7% in the last 20 years, typically ranging between 11% and 14%. LMT is able to translate its profits into Free Cash Flow and has had an average FCF margin of 8.8% in the last 20 years.
Balance Sheet: LMT’s balance sheet is quite leveraged, with an Equity Multiplier (Assets/Equity) of 7.67 at the end of FY 2023. Nevertheless, debt seems to be sustainable, with a 10x Interest Coverage ratio and a 1.6x Net Debt/EBITDA ratio.
Growth: LMT has had low but stable growth in the last 10 years, with a 3.3% Revenue CAGR, 7.3% EBIT CAGR and 5.5% FCF CAGR. In the last twenty years, there have been only two years with negative revenue growth and five years of negative EPS growth.
Valuation
At the time of writing, LMT is trading at $451.85 and has a market cap of $109.9B. It is priced at a TTM P/E ratio of 16.0x (earnings yield 6.25%) and EV/EBITDA of 12.5x. Considering the quality of the business and its strategic sector, the company looks attractive at the current price and that is why a deeper analysis is launched.
Objectives and key points of this article
Understand LMT’s business and products and analyse its demand both in the US and internationally.
Dig deeper in LMT’s fundamentals to study the sustainability of the ROCE and its competitive advantage.
Considering the leveraged balance sheet, assess the sustainability of LMT’s debt.
Reach a final conclusion whether an investment in LMT shares is worth it.
2. Business Overview
LMT makes a profit by winning bids raised from the US Government and the Department of Defense in four different categories: Aeronautics, Missiles and Fire Control (MFC), Rotary and Mission Systems (RMS) and Space.
The DoD identifies a need for a new defense product (e.g. fighter jet, missile system, etc) and LMT competes with other companies (i.e. Boeing, General Dynamics, L3Harris, Northtrop Grumman, RTX Corp.) by submitting a bid including a proposal for the product, the timeline and the associated costs.
If LMT wins the bid, LMT receives a contract and can start the development of the program. LMT makes a profit by fulfilling the contract at a lower cost than the established price. Contracts are of the following nature:
Fixed-price contracts : LMT performs the specified work for a pre-determined price. To the extent the actual costs vary from the initial estimates upon the price was negotiated, LMT will generate more or less profit or even incur a loss. Some fixed-price contracts have a performance-based component under which LMT may earn incentive payments or incur financial penalties based on performance (Fixed-price with incentive, FPI).
Cost-reimbursable contracts provide for the payment of allowable costs incurred during the performance of the contract plus a fee up to a ceiling based on the amount that has been funded.
Fixed-price contracts are inherently riskier than cost-reimbursable contracts because the revenue is fixed, while the estimate of costs required to complete the contract are subject to significant variability due to the nature of the sector.
Aeronautics (68%), MFC (67%) and RMS (64%) lean more towards fixed-price contracts, while the Space segment has 75% of the revenue linked to Cost-reimbursable contracts. Overall, as of FY 2023, LMT generated 60% of its revenue via Fixed-price contracts and 40% via Cost-reimbursable contracts.
In general, United States is the main customer for all divisions, accounting for ~70% of the revenue for the Aeronautics, MFC and RMS segments and even being the exclusive customer for the Space segment (~99% of the revenue).
Finally, most of the revenue is associated with the delivery of the products themselves (~85%, depending on the segment), while the remaining part is linked to the associated Services (~15%).
Revenue distribution (FY 2023)
Operating Profit distribution (FY 2023)
Asset and CapEx distribution (FY 2023)
Based on the figures displayed above, the following can be highlighted:
In general, revenue has been flat in the last 4 years across all business segments.
Aeronautics is the key business segment driving LMT’s returns, mainly due to its flagship product: the F-35.
The four business segments have similar operating margins: Aeronautics (10.2%), Missile and Fire Control (13.7%), Rotary and Mission systems (11.5%), Space (9.2%).
The Return on Assets (measured with Operating Profit) is different across segments: Aeronautics (21.4%), Missile and Fire Control (27%), Rotary and Mission systems (10.6%), Space (17.7%).
Although the Rotary and Mission Systems (RMS) accounts for ~25% of the revenue and operating profit, it is the most capital intensive business, with ~41% of the total assets.
The CapEx distribution across segments looks odd: Although the RMS has the most assets, it has the lowest Capital Expenditure requirements. On the opposite, 31.1% of the CapEx in FY2023 were dedicated to the Space segment, although it only accounted for 15.3% of the assets. This is not so clearly reflected in the Income Statement, as growth has been generally low for all segments.
2.1. Aeronautics
Aeronautics is the business segments that engages in the development and manufacturing of advanced military aircraft. It accounts for around 40% of the revenue and its major programs include:
F-22 Raptor - 5th generation fighter jet. It is a single-seat, twin-engine, all-weather stealth fighter aircraft developed for the United States Air Force (USAF). Although the plan was to have a larger fleet, only 187 F-22 Raptors were ever produced due to high costs ($150 million per aircraft) and the end of the Cold War. The program was terminated in 2009 and the USAF is the only operator.
C-130 Hercules - Four-engine turboprop military transport aircraft known for its versatility, reliability, and ability to operate from rough, unpaved runways. Production started in 1954 and is still ongoing. Over 4500 C-130 have been produced and more than 70 countries currently operate the aircraft. Its unit cost is estimated at $110 million per aircraft.
F-16 Fighting Falcon - Also known as the Viper, it is a single-engine, multirole fighter aircraft developed for the USAF. It is known for being a relatively low-cost (~$40 million per aircraft), high-performance fighter compared to other contemporary jets. Production is no longer active, but over 4600 F-16 have been produced in total, with more than 25 countries operating the fighter jet.
F-35 Lightning II
The F-35 deserves a detailed explanation, as it is LMT’s flagship product, generating 64% of the Aeronautics’ revenue and 26% of the total revenue.
It is a single-seat, single-engine, all-weather stealth multi-role combat aircraft that is intended to perform both air superiority and strike missions. The F-35 has three variants:
F-35A: conventional takeoff and landing (CTOL)
F-35B: short take-off and vertical landing (STOVL)
F-35C: carrier-based (CV/CATOBAR)
The program was launched in 2001, when the Lockheed Martin X-35 beat the Boeing X-32 to win the Joint Strike Fighter (JSF) program. The first model was an F-35B and entered service in July 2015 with the U.S. Marine Corps.
The USA plan to acquire 2456 units of the F-35 until 2044 and expects to use the jet as the bulk of the crewed tactical aviation for the U.S. Air Force, Navy and Marine Corps for several decades until 2070.
The program drew strong criticism for its unprecedented size, complexity, costs, and delayed deliveries, but is now considered the most advanced fighter jet in the world, only rivalled by the other two 5th generation fighter jets: the Chinese Chengju J-20 and Russian Sukhoi Su-57. Costs for an F-35 are estimated at $82.5M for the F-35A, $109M for the F-35B and $102.1M for the F-35C. These unit prices have been strongly reduced with respect to the initial values. In February 2011, it was estimated that one F-35 cost $305M, making it completely unaffordable for most countries besides the US. Since the price reduction, many countries have raised its interest on the program.
While information is obviously not always public, especially for current negotiations, several countries have already announced its plans to incorporate the F-35 into their defense forces:
Although defense programmes depend mainly on home countries, it is a clear sign of success when the same product is exported internationally and there is external demand. In this case, over 1000 international deliveries are expected, which implies steady revenue stream in the upcoming years.
Initially, manufacturers are typically allowed to produced at a so-called Low Rate Initial Production (LRIP), where small batches can be produced and are strongly monitored in order to guarantee the quality of the product. Fortunately, the DoD approved, on March 12,2024, the so-called Milestone C / Full Rate Production (MSC/FRP). Nevertheless, LMT was already producing F-35 jets at a high rates, but it is now expected to produce around 156 fighter jets per year.
Key aspect: F-35 sustainment activity
2.2. Missiles and Fire Control (MFC)
The MFC segment provides air and missile defense systems, tactical missiles and air-to-ground precision strike weapon systems, and fire control systems. The major programs include:
Patriot Advanced Capability-3 (PAC-3) - Advanced defensive missile for the US Army and international customers designed to intercept and eliminate incoming airborne threats. Is has recently gained reputation as it has been delivered to Ukraine as part of their air-defense system.
Terminal High Altitude Area Defence (THAAD) - Transportable defensive missile system designed to engage targets both within and outside of the Earth’s atmosphere.
Multiple Launch Rocket System (MLRS) - Highly mobile, automatic system that fires surface-to-surface rockets and missiles from the M270 and High Mobility Artillery Rocket system (HIMARS) platforms. This platform will be compatible with the Precision Strike Missile (PrSM), the next generation of precision strike surface-to-surface weapon system.
Joint Air-to-Surface Standoff Missile (JASSM) - Air-to-ground missile launched form fixed-aircraft.
Long Range Anti-Ship Missile (LRASM) - Precision guided anti-ship missile derived from JASSM and designed to operate at very long range.
Hellfire - Air-to-ground missile used on rotary and fixed-wing aircraft.
Javelin program - one-person portable and platform employable anti-tank and multi-target precision weapon system. Join venture between Lockheed Martin and RTX Corporation.
Some of these systems, such as the PAC-3, MLRS (HIMARS) and Javelin missiles, have increasingly gained popularity internationally as they have participated in the Ukraine conflict and have tremendously aided the country in its defense efforts.
Key aspect: Increased PAC-3 production rates and increased demand for HIMARS and Guided Multiple Launch Rocket Systems (GMLRS)
2.3. Rotary and Mission Systems
The RMS designs, manufactures, services and supports various military and commercial helicopters, surface ships, sea and land-based missile defense systems, radar systems, laser systems, sea and air-based mission and combat systems, command and control mission solutions, cyber solutions, and simulation and trianing solutions. Major programs include:
Sikorsky helicopter program - BLACK HAWK®, Seahawk® and CH-53K King Stallion heavy lift helicopters; Combat Rescue Helicopter (CHR) and VH-92A helicopter. Sikorsky is a subsidiary of Lockheed Martin since 2015.
Aegis Combat System programs, Littoral Combat Ship (LCS) and Multi-Mission Surface Combatant
Key aspect: Radar surveillance systems and CH-53K King Stallion heavy lift helicopter
2.4. Space
Space is engaged in the design, development and production of satellites, space transportation system and strategic, advanced strike and defensive systems. Major programs include:
Next Generation Overhead Persistent Infrared (Next Gen OPIR) system - Provides missile warning capabilities
Trident II D5 Fleet Ballistic Missile (FBM) - Submarine-launched intercontinental ballistic missile
Orion Multi-Purpose Crew Vehicle (Orion) - Spacecraft for NASA
Next Generation Interceptor (NGI)
Global Positioning System (GPS) III - Program to modernise the GPS satellite system
Hypersonics programs
Key aspect: Modernization and enhancements to the Trident II D5 Fleet Ballistic Missile (FBM)
3. Fundamentals
Profitability
Lockheed Martin has historically had remarkable performance in terms of Return on Capital:
From an accounting point of view, LMT includes materials, labor, subcontracting costs and indirect costs (overhead, general and administrative) in the Cost Of Sales. For this reason, the Gross Margin and Operating Margin are nearly the same. Gross Margin and Operating Margin have ranged between 9% and 14% in the last 10 years.
Return on Invested Capital (ROIC)1 and Return on Capital Employed (ROCE)2 have ranged between 17% and 28% in the last 20 years, which is significantly above the Cost of Capital. Return on Capital above the Cost of Capital is key to ensure that value is created with growth and reinvestment opportunities.
Due to the high-leverage of the Balance Sheet, Return on Equity will not be considered as a proper metric for this analysis.
Balance Sheet
As mentioned previously, Lockheed Martin’s Balance Sheet is considerably leveraged:
As of 31st December 2023, LMT had:
Current Debt: $168M
Long-term Debt: $17291M
Leases: $1177M
Cash & Cash Equivalents: $1442M
With an interest expense of $916M, the Cost of Debt at the end of FY 2023 was 5.5%.
The debt repayment plan can be seen below, based on the data provided by the company in the last 10-K. As it can be seen, in some cases the debt repayment is foreseen far in the future.
Additionally, LMT reports “Other notes with rates from 4.85% to 8.50%, due 2024 to 2041” totalling $1479M. Unfortunately, there is no way to place these $1479M in the graph. With these data, it is possible to make an initial estimation of the expected Interest expense:
With a stable Operating Profit of around $8000M, the intest coverage ratio is ~10x, which is absolutely healthy and safe.
Of course, this estimation is only valid for the frozen baseline as provided in the 10-K Report for FY 2023, assuming no new debt issuance or debt repayment. This will obviously not be the case, given the fact that, for example, LMT refinanced in 2022 $500M at 3.10% rate with new senior unsecured notes at a higher cost due to to the global raise in interest rates. If we include the principal repayments, it looks as follows:
In FY 2023, Lockheed Martin issued new debt as follows:
$500M due 2028 at 4.45% rate
$850M due 2034 at 4.75% rate
$650M due 2055 at 5.20% rate
$119M repayment for “Other notes with rates from 4.85% to 8.50%, due 2024 to 2041”
In FY 2022, LMT issued a net total of $3759M of senior unsecured notes. The company has an additional Revolving Credit Facility that amounts to $3.5B.
Another point to highlight from LMT’s balance sheet is the enormous amount of Goodwill ($10799M) and Intangible Assets ($2212M). Both combined, they account for 25% of the Total Assets.
In 2015, acquired Sikorsky Aircraft Corporation from United Technologies Corporation (UTC). This purchase price of the acquisition was $9.0B and it was financed with $6.0B from a revolving credit facility, $2.0B from cash on-hand and $1.0B from new debt. The $6.0B from the revolving credit were then refinanced with the issuance of new debt at the end of 2015. As a result of this acquisition, the segment “Mission Systems and Training (MST)” was renamed “Rotary and Mission Systems (RMS)”. Consequently, this business segment has most of the goodwill assets:
In 2016, LTM completed the divestiture of the Information Systems & Global Solutions (IS&GS) business, which merged with a subsidiary of Leidos Holdings, Inc. As a result of the exchange, LTM received a $1.8B cash payment.
LMT has been carrying a significant amount of goodwill since 1996, when an increase of $7600M was reported as a result of the acquisition of Loral Corporation’s defense electronics and system integration businesses.
Since then, no significant M&A acquisition has been done by LMT.
Growth
Despite the great performance in terms of Return on Capital Employed and the sustainable debt levels (in any case, not ideal), Lockheed Martin has had several years with stagnating revenue.
Historically, it can be seen that LMT has periods of high revenue growth followed by a deceleration or even negative growth. There have actually been only two years of negative revenue growth out of twenty years, but this number increases to five for operating profit. Nevertheless, reverse to the twenty-years mean revenue/net income growth of 3% seems to be realistic, supported by the already committed F-35 deliveries and strong international demand due to an increase of defense budgets all around the world.
4. Capital Allocation
In the last ten years, Lockheed Martin has distributed Operating Cash Flow as follows:
Cash flow from investing activities: -35%
Capital Expenditures: -21%
Net acquisitions (mainly Sikorsky): -16%
Cash Flow from financing activities: -67%
Dividend payment: -38%
Debt repayment(issuance): +8% (i.e. cash inflow, debt was issued)
Stock buyback: -19%
Net change of cash: -2%
The strong cash outflow in net acquisitions for 2015 refers to the purchase of Sikorsky, which had a total price of $9B, at an EV/EBITDA (LTM) of 13.0x.
Besides this one-time extraordinary purchase, no significant M&A activity is visible and LMT’s CapEx needs have been quite stable at 21% of operating cash flow, slightly above depreciation.
Shareholder distribution has also remained stable and predictable, with an average payout ratio of 47% and slow but steady growth in dividend per share. At the moment, LMT offers a 2.7% dividend yield.
Lockheed Martin engages in additional shareholder remuneration by constantly repurchasing stock. The number of shares has been steadily decreasing since 2004 with a reduction of ~200 million shares, from 447.1M in 2004 to 251.2M, with greater emphasis in 2022 and 2023, where Lockheed Martin repurchased ~10% of shares in only 2 years. As a consequence, while Net Income has grown at a 8.86% CAGR since 2004, EPS has grown at a 12.05% CAGR.
In FY 2023, LMT repurchased a total of 6715890 shares at an average price of $447.18 for a total of $6708M, which implies an additional shareholder yield of ~5%.
5. Corporate Governance
Lockheed Martin has undergone several management changes in recent years:
The main leadership positions have all been changed since 2020, an aspect that could be considered concerning. Although most Executive Officers have a longer tenure, it must be challenging to keep a unique strategic vision with so many changes in important positions.
Although it is not so uncommon, the fact that Mr. Taiclet holds the Chairman of the Board of Directors, President & CEO roles is also not promising. While this can help streamline decision-making, it might lead to a lack of oversight and reduces the Board’s leverage to challenge the CEO.
In FY 2023, Mr. Taiclet received a base salary of $1.75M (8%), unchanged since 2021. In addition, an additional annual incentive of $3.33M (190% of base salary, 16% of total compensation) was granted.
Finally, Mr. Taiclet was granted an annual LTI award of $16M, consisting of 50% in Performance-based Stock Units (PSU), 30% in Restricted Stock Units (RSU) and 20% in the cash-based LTI performance award (LTIP). RSUs will cliff-vest ahfter three years, while the payout of PSUs and LTIP will be based upon the results at the end of the three-year performance period relative to the three-year performance goals established in the beginning of 2023.
As of February 2024, Mr Taiclet owned ~48000 shares of Lockheed Martin (~$21M)
According to LMT’s own Proxy Statement, CEO’s remuneration is close to the 75th percentile within a range of peer companies:
In general, the compensation seems to be tied to the fundamental evolution of the company and the key parameters are Sales, Operating Margin and Free Cash Flow for the short-term variable pay and Total Shareholder Return, ROIC and Free Cash Flow for the long-term variable pay. This is seen as a positive aspect.
Unfortunately, LMT does not disclose the specific values of Free Cash Flow and ROIC that the company sets to establish CEO’s compensation, so the detailed explanation provided in the Proxy Statement does not help much. As a reference, the 2021-2023 LTIP and PSU Awards set a ROIC of 21.1% as target and a total Free Cash Flow of $22.4B.
In conclusion, this brief assessment of the leadership and compensation scheme is not seen as particularly positive but also not as a red flag by itself.
6. Industry
6.1. Industry map
As usual, the best way to understand a business is to build an industry map based on the Five Forces from Michael Porter. Although an industry map should probably be built for each business segment, a general one will be built for the sake of general understanding.
Note that the companies listed in the figure below do not represent an exhaustive list.
It is important to highlight that it happens quite often that the Five Forces are mixed for the aerospace & defense sector, as companies that compete against each other are also their own suppliers. In many cases, companies bid for a new program proposed by the DoD and, although only one can be awarded the main contract, the other candidates usually end up being main suppliers for the same program.
Suppliers
In order to build its highly-advanced and complex products, Lockheed Martin relies on a huge amount of suppliers. In some cases, these suppliers maybe be small and medium companies providing simple but necessary standard parts (e.g. screws, rivets, washers, etc) and therefore having a low bargaining power.
In other cases, the supplier might be highly specialised or might provide a key system of the product, resulting in a much higher supplier power. Furthermore, the high-quality requirements inherent to the aerospace & defense industry require suppliers to have specific certifications and quality standards that may allow them to gain some bargaining power.
In general, it could be considered that the supplier power is moderate. Given the huge amounts of money spent by the DoD, it is in the best interest of both suppliers and Lockheed Martin to provide their services at a fair price. If one decides to strangle the other, the industry overall suffers and both lose the bigger picture.
Buyers
Lockheed Martin’s customers are quite reduced: mainly the USA Government and Department of Defense, complemented by international defense departments in allied countries.
The Department of Defense could be classified as a Customer with strong power. However, the DoD may not exercise its full power as it is in the interest of the country to maintain a healthy relationship with its main strategic providers of aerospace & defense products.
On the other hand, third-party government have little leverage. In many cases, these third-countries do not have the capacity to produce products such as the F-35 and it is widely known that American products are on a higher lever in terms of quality. Nevertheless, regions such as the European Union or other powerful countries may decide to promote their own industries due to geopolitical reasons.
Substitute products
As of today, there are basically no substitute products. Should there exist a substitute product, it is highly likely that it will be Lockheed Martin itself the company developing it.
It is hard to imagine a world where jet fighters, air-defense systems or tactical helicopters are replaced by an alternative product.
Thread of new entrants
Similarly, Lockheed Martin’s business, and that of the already existing aerospace & defense companies, is heavily protected against new entrants. Lockheed Martin’s barriers to entry are caused by the following:
Switching costs: Once a strong relationship is built between government agencies and the Company, the customer cannot simply switch product. It takes several years, even decades, and billions in funding to reach the final product. Therefore, once the contract is awarded and Lockheed Martin successfully fulfils the requirement, there is no possibility to change product.
Proprietary technology: the level of intangible assets and proprietary technology required to build LMT’s products is so high that this alone prevents new entrants.
Capital investments: Similarly, the LMT’s products require an enormous amount of capital investments, not only in fixed assets but also in talent and skilled workforce.
For this reason, the thread of new entrants, the most important force according to Bruce Greenwald, is very low.
Competitors
The Industry is organised between four or five big providers of aerospace & defense products. These companies fiercely compete for new contracts awarded by the Department of Defense and hence the competitor power can be considered high.
Lockheed Martin’s main competitors are:
Aeronautics: In the Aeronautics business division, Lockheed Martin currently faces very little competition for the 5th Generation Fighter Jets due to its advanced features and the participation of multiple countries in its development program. Nevertheless, there are currently several 4th Generation Fighter Jets that compete for a lower-cost alternative:
The Boeing Company: F-18 Super Hornet
Saab (Sweden): Gripen E/F
Dassault Aviation (France): Rafale
Eurofighter GmbH (Europe, Airbus/BAE Systems/Leonardo): Eurofighter Typhoon
Rotary and Missions Systems
Helicopters: The Boeing Company (Apache Helicopter), Airbus (Tiger, NH90), Leonardo. Although they may not necessarily fall on the same product category, these companies may compete for future developments.
Mission Systems: General Dynamics, BAE Systems, L3Harris
Missile and Fire Control
RTX Corporation, Northrop Grumman, MBDA (European consortium)
Space
Northrop Grumman
Boeing
SpaceX
As mentioned previously, these competitors are also in many cases suppliers of Lockheed Martin for certain programs.
Although it is hard to compare a complete company with another (they compete at product level), the following companies will be taken into account for a quantitative comparison:
RTX Corporation (RTX)
Northtrop Grumman (NOC)
General Dynamics (GD)
L3Harris (LHX)
Boeing (BA)
BAE Systems (BA.L)
6.2. Competitors
Although the ROE comparison may not be realistic due to the high-leveraged balance sheet that Lockheed Martin has, it seems that it is the company with both the highest Return on Capital Employed and Return on Assets among the peer groups.
Lockheed Martin achieves this by having the best combination of Turnover ratios and margins:
When comparing Balance Sheets, it is clear that Lockheed Martin is highly leveraged, but the debt sustainability might not be the worst. LMT’s liquidity is more than enough to cover short-term liabilities and, while the Debt/Equity ratio is the highest, the Net Debt / EBITDA ratio is the second lowest, meaning that Lockheed Martin is would be able to pay-off its debts quite fast with its gross operating income:
In terms of shareholder remuneration, LMT has the highest dividend yield while maintaining a healthy payout ratio. As we can see, RTX Corporation has a higher dividend yield but its Payout Ratio is almost maxed out.
When comparing growth, it seems that growth has been rather low overall in the industry and LMT has managed to have the second highest EPS growth. BA’s EPS growth is not representative, as EPS went from -1.12 to -3.67, which results in a positive CAGR but definitely a negative result for Boeing.
In conclusion, Lockheed Martin scores as follows:
ROCE (the most important metric): 1st
Net Debt / EBITDA: 2nd
Dividend yield: 1st
Growth: 2nd (EPS), 3rd (Revenue)
Based on this comparison, it should be expected that Lockheed Martin has a slight premium valuation with respect to its peers.
However, on the contrary, Lockheed Martin has both the best earnings yield (6.3%, PE 15.9x) and EBITDA yield (8%, EV/EBITDA 12.5x).
7. Valuation
7.1. Multiples
With a PE Ratio of 16x and EV/EVIBTDA of 12.5x, the basic multiples do not seem to be very challenging for such a well-established company with high Returns on Capital and strong barriers to entry. These multiples seem to be returning back to the historical average for Lockheed Martin (the high PE value in 2017 is not representative due to extraordinary tax expense):
However, it is clear the revenue growth in the last few years has been quite disappointing and the market might be punishing the company for it. Although the F-35 seems to have overcome its main difficulties and has established itself both nationally and internationally, this has not been reflected yet in the bottom line of the income statement.
It is always interesting to separate the value of a company into two parts: the steady-state value and the future value creation.
Assuming that the current NOPAT is sustainable, the steady-state value is calculated as:
With a Market Cap of $108.3B, the current value of Lockheed Martin’s operations captures ~57% of the overall value.
7.2. Reverse Discounted Cash Flow
A good way to approach valuation is to analyse market expectations and assess whether they are realistic or not.
For this, a simple Reverse Discounted Cash Flow analysis can be performed with the expected growth in Free Cash Flow. Depending on the selected terminal growth rate, the market expects Lockheed Martin to grow its Free Cash Flow at a 4.0% - 8.8% CAGR, which seems to be match the historical average for a standard terminal growth of 3.0%.
The Reverse Discounted Cash Flow analysis can be further extended to assess the market expectations for the underlying business. The following parameters have been taken into account as range values, based on historical averages and standard deviations:
10Y Revenue growth: -4.0% - 11.3%
10Y Operating Margin: 4.6% - 14.9%
10Y Sales/Capital: 1.15x - 2.95x
Tax Rate: 15.0% (5Y average)
The Operating Margin, average Tax Rate and Sales/Capital ratio helps derive the resulting ROIC. The figure below shows all possible combinations of Revenue Growth and ROIC that so that a Discounted Cash Flow model matches with the current market capitalisation.
The 10Y average ROIC is 20.5%, and the 10Y Revenue CAGR is 4.0%. With a 3% terminal growth rate, Lockheed Martin is expected to slightly improve its performance. Lockheed Martin can achieve that by maintaining its 20.5% ROIC and having higher revenue growth, or by maintaining its 4.0% revenue growth and improving its ROIC. Alternatively, a combination of both is also possible.
In the last five years, Lockheed Martin has had a ROIC above 25%, so it seems that the lagging variable at the moment is Revenue Growth, which has been flat in the last three years. For FY 2024, Lockheed Martin expects sales of $68.5B to $70B, in line with analysts' estimates of $68.65 billion, and Earnings per Share in the range of $25.65 - $26.35 (~5% decline)
9. Conclusion
On the positive side, Lockheed Martin is a high-quality company with sustainable high Return on Invested Capital. The company is protected by strong barriers to entry in the form of intangible assets and high capital investment requirements and hence only competes with a reduced number of companies. Additionally, LMT offers an attractive remuneration and decreasing share count and is not trading at challenging valuation multiples.
On the negative side, Lockheed Martin has had disappointing growth in recent years and has a high (but sustainable) amount of debt. Additionally, the recent changes in executive positions is also regarded as a negative point.
A potential Total Shareholder Return can be derived using the linked article from Michael J. Mauboussin and Dan Callahan.
A Total ShareHolder Return can be derived with the following conservative assumptions:
Earnings per share growth (3% + 2% = 5%) → The resulting EPS growth based on net income growth and change in shares outstanding is 5%, which is significantly lower than the previous ten years (9.71%).
Net income growth (3%) → In the last ten years, Lockheed Martin has had Net income growth of 6.71%. Although revenue growth has been 0% in the last three years, long-term stagnant revenue does not seem to be plausible for such an important and strategic company, especially given the current backlog for the F-35 program and the overall increase in defense spending worldwide. An intermediate value of 3% seems like a realistic value, lower than the fundamental expected growth ( 21% ROIC x 25% Reinvestment ratio).
Change in shares outstanding (2%) → In the last ten years, Lockheed Martin has reduced its share count at a 2.46% CAGR. This may continue in the near future, but a lower rate of 2% will be assumed as a conservative approach.
P/E multiple change (0%) → The current P/E ratio is in line with historical averages, hence no significant changes in the P/E ratio will be assumed.
Dividend (2.7%) → Current Dividend Yield is 2.7%. This figure assumes no dividend growth.
Dividend reinvestment (0%) → In order to simplify, it will be assumed that dividends are not reinvested.
Given the conservative assumptions that have been taken, it is considered that an investment in Lockheed Martin’s shares:
Does not represent a significant or complete loss of the investment
Offers an attractive return despite the conservative assumptions taken
May have a significantly better TSR if Lockheed Martin manages to grow its Revenue and Net Income at historical levels.
However, it is also true that the calculated TSR does not offer a return significantly different from what the market has historically returned. The company may be added as a high-quality, defensive, blue chip, but will not have remarkable alpha with respect to the market.
All content on this site is for informational purposes of a general nature only, and does not address any circumstances of any particular individual or entity. Do not construe any such information or material as legal, tax, investment, financial, professional or any other advice. Content on this site does not represent or constitute any solicitation, inducement, recommendation, endorsement or offer by this Substack or any third party service provider to buy or sell securities, commodities, digital assets or any financial instruments. Nothing on this sites constitutes professional and/or financial advice, nor does any information found on this site constitute a comprehensive or complete statement of the matters discussed. InvestingHub is not a fiduciary by virtue of any person's use of or access to this site and content. Any information, materials, statements and/or data set out herein is subject to change anytime without notice and as such, no reliance must be placed on fairness, accuracy, completeness or correctness of any information and materials contained on this site.