Lockheed Martin: Is it time to get aboard?
Opdateret: 15. apr.
Defense companies may thrive in all economic environments as they are primarily founded by Governments, which means that revenues are pretty much guaranteed. Another benefit for defense companies is that their contracts are often very long and last for decades. Lockheed Martin is the largest contractor of the U.S. Department of Defense, and this is my analysis of the company.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that at the time of writing, I do not own shares in Lockheed Martin or any of their competitors. If you would like to copy or see my portfolio, you can read about how to do so here.
Lockheed Martin Corporation is an American aerospace, defense, arms, security, and advanced technology company. It was formed by the merger of Lockheed Corporation and Martin Marietta in 1995, and it is headquartered in Maryland very close to Washington D.C. Lockheed Martin Corporation it is involved in four different business segments: Aeronautics (41 % of net sales in 2022), Rotary and Missions Systems (24 % of net sales in 2022), Space (18 % of net sales in 2022), and Missiles and Fire Control (17 % of net sales in 2022). The highest margin segment is Missiles and Fire control with a 14,4 % operating margin, followed by Aeronautics (10,6 % operating margin), Rotary and Mission systems (10,4 % operating margin), and Space (9,1 % operating margin). Lockheed Martin is by far the largest contractor of the U.S. Department of Defense, as they were awarded 11,1 % of total contract funds in 2022, while the runner up was awarded 6,1 %. The high barriers to entry the defense industry, and the long-term contracts means that Lockheed Martin has a switching moat. Later we will investigate the numbers but let us first have a look at their management.
Their CEO is James Taiclet. He was appointed in 2020, meaning that it is not possible to evaluate on how he has done at Lockheed Martin, but it is possible to investigate his credentials. James Taiclet is not new to Lockheed Martin as he has served on the board two years prior to being the CEO. James Taiclet actually started his career as a Air Force pilot, where he also worked as an instructor before studying engineering and later studied international relations. Prior to being announced as the CEO of Lockheed Martin, he was the CEO at American Tower. Under James Taiclet's leadership American Tower went from almost being delisted from from the Stock Exchange and having a market cap on $2 billion to be a global player with assets in 19 countries and a market cap on $100 billion. During his time at American Tower the Harvard Business Review named James Taiclet as one of the world's top-performing CEOs seven times. He is also a member of the Council on Foreign Relations and was named co-chair of the U.S. - India CEO Forum by the U.S. Department of Commerce. All of this means that James Taiclet has shown great results as a manager, while he also has extensive experience in aerospace activities and international relations.
I believe that Lockheed Martin has a switching moat. I really do like the management as well. Now let us investigate the numbers to see if Lockheed Martin lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first and most important number we will look into is the return on investment capital, also known as ROIC. We want to see 10 years of history and we want the numbers to be above 10 % in all years. Lockheed Martin has delivered a fantastic ROIC over the years, with their lowest ROIC being 14,6 %, which is still very acceptable. ROIC has decreased slightly in 2021 and 2022 but as Lockheed Martin still delivers a ROIC above 20 %, it is hardly anything to worry about. I would love to invest in a company that has continuously delivered a ROIC like this.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. Overall, the numbers are a bit mixed, and it is not surprisingly to see 2017 being the year with the lowest equity, as it was the year with the lowest ROIC. Some years are affected by acquisitions like when Lockheed Martin acquired Sikorsky in November 2015. Despite the drop in equity in 2022, it is nice to see that the equity is much higher in 2022 than it was 10 years ago in 2013.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has left remaining after paying all of its financial obligations, I use the margin for it to make more sense. Free cash flow yield is the free cash flow per share a company is expected to earn against its market value per share. Lockheed Martin has delivered a solid free cash flow over the years, and there are not many outliers. Thus, it shows the resilience of the business that Lockheed Martin has.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by earnings. Doing the calculation on Lockheed Martin, I can see that Lockheed Martin has 2,69 years earnings in debt. It is to the larger side, and I would like to see it being lower. However, it is still within the acceptable and debt is not a concern for me if I should invest in Lockheed Martin.
Based on the numbers and debt, Lockheed Martin looks to be a great company to invest in. However, all investments have some risks and so do Lockheed Martin. Depending on the U.S. defense budget. Lockheed Martin is the largest contractor of the U.S. Department of Defense. Hence, they are very dependent on the U.S. defense budget. While national defense has historically been one of the top priorities of any U.S. Government, and in 2023 the defense budget was increased by 10 %. However, there are no guarantee that it will continue like that, especially not with the ongoing discussions in Congress regarding the debt ceiling. In 2011, when Congress also discussed the debt ceiling, it resulted in defense budget being cut, which could happen again. Continued high inflation. In their 2022 fourth quarter earnings call, management mentioned that they have not seen inflation having a significant impact, as Lockheed Martin has fixed price contract with suppliers. However, management also mentioned that in the current environment, it is hard to negotiate long-term fixed priced contracts, and that they are getting squeezed by both customers and suppliers. It means that the new contract that Lockheed Martin signs may not be as favorable as previously and could have an impact on margins moving forward. The F-35 program represents much of revenue. The F-35 program is Lockheed Martin's largest program and represents 27 % of their net sales in 2022. If the U.S. Government or other Governments decides to cut spending on the program, it could have a significant impact on Lockheed Martin. It means that when Lockheed Martin is so dependent on this program deliveries must run smoothly, and in the end of 2022, there was an issue in deliveries that resulted in a pause in flight operations, which affected deliveries. It didn't affect the program but when one program represents so much of the revenue, it is a risk.
There are also plenty of reasons to invest in Lockheed Martin. One is their large backlog. The backlog means that Lockheed Martin isn't going out of business anytime soon. In 2022 Lockheed Martin achieved record orders as orders grew by 11 %. It has resulted in an order backlog of $150 billion, which more than two years of revenue. We will probably see more orders moving forward, as most NATO members are still not meeting the target of 2 % of GDP should be used on the defense budget, and in the unfortunate state that the world is in, NATO members may be more willing to spend on defense budget. Furthermore, the conjoined NATO army has already declared that they will increase military budget by 25,8 %. Another reason to invest is 1LMX. Lockheed Martin has announced a 7-year program to transform its end-to-end business processes and systems called 1LMX. The goal of the program is to implement new digital tools in their operations and use model-based engineering to enhance the speed of the products to reach the market. Furthermore, Lockheed Martin believes that 1LMX will find synergies between their four different segment, and other cost-reduction opportunities that will increase operating efficiency, which in return will increase profits. Dividends and buybacks. Lockheed Martin has a tradition of returning capital to shareholders through dividends and buybacks. In 2022 management returned approximately $11 billion to shareholders through dividends and buybacks. Lockheed Martin has raised its dividend in the last 20 years, while they have bought back 20 % of their shares outstanding in the last decades. We will probably see that Lockheed Martin will continue to raise their dividend, and they still have $10 billion left of their share repurchase program.
All right, we have gone through the numbers and risks regarding Lockheed Martin, and now it is time for us to calculate a price for Lockheed Martin. In order to calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS as it was in 2022 at 21,66. I chose an Estimated future EPS growth rate of 8 (management believe free cash flow to grow by mid-single digits but margins should improve), Estimated future PE 16 (which the double of the growth rate, as the historically PE for Lockheed Martin has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY" we come up with the sticker price (some call it fair value or intrinsic value) of $184,94, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Lockheed Martin at price of $92,47 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The Operating Cash Flow last year was 7.802. The Capital Expenditures was 1.670. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 1.169 in our further calculations. The Tax Provision was 948. We have 254 outstanding shares. Hence, the calculation will be like this: (7.802 - 1.670 + 948) / 254 x 10 = $278,74 in TEN CAP price.
The last calculation is the PAYBACK TIME. It is also described in "MY STRATEGY". With the Free Cash Flow Per Share at 23,40 and a growth rate of 8 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $268,81.
I believe that Lockheed Martin is a great company with a great management. The company should perform well through all economic environment, which is something that I would add to my portfolio. Lockheed Martin has also consistently delivered a high ROIC, which indicate that it is a quality company. There are some risks regarding the U.S. defense budget being cut, but it is probably only for the short-term, so it isn't something I'm overly concerned about. New contracts could affect margins but if Lockheed Martin manages to deliver on 1LMX, margins should still increase. Lockheed Martin has a large backlog, which means that even if Government budgets get tighter around the world, it shouldn't affect business much. I was surprised to learn that Lockheed Martin has reduced their shares outstanding by 20 % over the last decade. I believe it shows that management is shareholder friendly. I would love to add Lockheed Martin to the portfolio at the right price. If Lockheed Martin drops to the TEN CAP price at $278,74, I will definitely be a buyer. I may even add it at a higher price, even though it means I will get a lower discount than 50 %.
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