Defense companies may thrive in all economic environments as they are primarily funded by governments, which means that revenues are relatively guaranteed. Another benefit for defense companies is that their contracts are often very long-lasting, spanning decades. Lockheed Martin is the largest contractor for 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 start by mentioning that at the time of writing this analysis, I do not own any shares of Lockheed Martin. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I do not own any stocks in any of Lockheed Martin's direct competitors either. Thus, I have no personal stake in Lockheed Martin. If you want to purchase shares or fractional shares of Lockheed Martin, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
The Business
Lockheed Martin Corporation is an American aerospace, defense, arms, security, and advanced technology company. Lockheed Martin Corporation was formed in 1995 through the merger of Lockheed Corporation and Martin Marietta. It is headquartered in Maryland, which is located very close to Washington, D.C. The company is involved in four different business segments: Aeronautics (accounting for 41% of net sales in 2023), Rotary and Missions Systems (accounting for 24% of net sales in 2023), Space (accounting for 18% of net sales in 2023), and Missiles and Fire Control (accounting for 17% of net sales in 2023). The highest operating margin is in Missiles and Fire Control, at 13,7%. It is followed by Rotary and Mission Systems (11,5% operating margin), Aeronautics (10,3% operating margin), and Space (9,2% operating margin). The Aeronautics segment offers combat and air mobility aircraft, unmanned air vehicles, and related technologies. The Missiles and Fire Control segment provides air and missile defense systems, tactical missiles, air-to-ground precision strike weapon systems, and fire control systems. The Rotary and Mission Systems segment offers military and commercial helicopters, surface ships, sea and land-based missile defense systems, radar systems, sea and air-based mission and combat systems. The Space segment provides satellites, space transportation systems, strategic, advanced strike, and defensive systems, as well as classified systems and services to support national security systems. Lockheed Martin is the largest contractor of the U.S. Department of Defense, having been awarded 14,7% of total contract funds in 2023. The runner-up, on the other hand, was awarded 6,0%. The high barriers to entry in the defense industry, along with long-term contracts, mean that Lockheed Martin has a moat.
Management
The CEO is James Taiclet. He was appointed as CEO in 2020. James Taiclet was not new to Lockheed Martin, as he served on the board for two years before becoming the CEO. James Taiclet actually started his career as an Air Force pilot, where he also worked as an instructor before studying engineering. Later, he pursued studies in international relations. Before being appointed as the CEO of Lockheed Martin, he held the position of CEO at American Tower. Under James Taiclet's leadership, American Tower transformed from nearly being delisted from the Stock Exchange and having a market capitalization of $2 billion to emerging as a global player with assets in 19 countries and a market capitalization of $100 billion. During his tenure at American Tower, James Taiclet was named one of the world's top-performing CEOs by the Harvard Business Review on seven occasions. 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. I believe that James Taiclet has demonstrated exceptional managerial skills and has a wealth of experience in aerospace operations and international relations. Therefore, I am confident in James Taiclet leading Lockheed Martin moving forward.
The Numbers
The first and most important metric we will examine is the return on invested capital, also known as ROIC. We require a 10-year history where all figures exceed 10% each year. Lockheed Martin has consistently delivered a fantastic return on invested capital (ROIC) over the years, with their lowest ROIC being 15,5 %, which is still very acceptable. In the past three years, ROIC has not reached the heights of the previous three years, but Lockheed Martin still managed to deliver an ROIC above 20% in all three years. It is encouraging that the Return on Invested Capital (ROIC) increased in 2023, which could suggest that Lockheed Martin is on the right path to deliver an ROIC above 30% again. Overall, I'm encouraged by the numbers as Lockheed Martin has delivered a Return on Invested Capital (ROIC) above 20% in nine of the past ten years.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. Overall, the numbers are a bit mixed. It is not surprising to see 2017 having the lowest equity, as it also had the lowest Return on Invested Capital (ROIC). Some years are affected by acquisitions, such as when Lockheed Martin acquired Sikorsky in November 2015. Despite the drop in equity since 2021, it is nice to see that the equity is much higher in 2023 than it was 10 years ago in 2014. One reason for the recent drop in its equity is that Lockheed Martin has used debt to repurchase shares.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is not surprising to note that Lockheed Martin has consistently generated positive free cash flow every year for the past ten years. Free cash flow increased slightly in 2023 compared to 2022, which is an encouraging sign. The levered free cash flow margin has been consistently between 9% and 11% in most years, but it decreased slightly in 2023, reaching its lowest point since 2018. This decline is somewhat concerning, and I am hopeful for an improved levered free cash flow margin in 2024. The free cash flow is lower than the five-year average, but since it is above 5%, it is still relatively high. This could indicate that the shares are not excessively expensive. However, we will reassess this later in the analysis.
Debt
Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a period of 3 years. We do this by dividing the total long-term debt by earnings. Upon calculating Lockheed Martin's financials, I have determined that the company has 2,78 years of earnings in debt. It is on the larger side, and I would like to see it lower. However, it is still within an acceptable range, and debt is not a concern for me when considering whether to invest in Lockheed Martin.
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Risks
Based on the financial figures and debt, Lockheed Martin appears to be a promising company for investment. However, all investments carry some risks, and Lockheed Martin is no exception. Depending on the U.S. defense budget. Lockheed Martin derived 73% of its total consolidated net sales from the U.S. Government in 2023. Lockheed Martin expects to continue deriving most of its sales from work performed under U.S. Government contracts. A reduction in overall U.S. defense spending, due to shifting priorities, budget compromises, or other factors, could adversely affect their business. Budget uncertainty, the potential for U.S. government shutdowns, the use of continuing resolutions, and the federal debt ceiling can adversely affect the industry and funding for programs. If appropriations are delayed or a government shutdown were to occur and continue for an extended period of time, Lockheed Martin could be at risk of reduced orders, program cancellations, and other disruptions, as well as nonpayment. These issues would impact Lockheed Martin's profitability.
The F-35 program represents a significant portion of revenue. The F-35 program, which comprises multiple development, production, and sustainment contracts, is Lockheed Martin's largest program and represented 26% of their total consolidated net sales in 2023. A decision by the U.S. government, international partners, or foreign military sales customer countries to cut spending on this program or reduce or delay planned orders would have an adverse impact on Lockheed Martin's business and results of operations. Given the size and complexity of the F-35 program, Lockheed Martin anticipates continual reviews related to aircraft performance, program and delivery schedule, cost, and requirements as part of the Department of Defense, Congressional, and international countries' oversight and budgeting processes. This indicates that this is an ongoing risk.
Competition. Lockheed Martin operates in a highly competitive industry, and their competitors may have more extensive or specialized engineering and technical capabilities than they do in certain areas. Their competitors may develop new technologies, products, or services that could potentially replace Lockheed Martin's current offerings. Additionally, if competitors can offer lower-cost services and products, or provide services or products more quickly at equivalent or reduced costs, Lockheed Martin may lose new business opportunities or contract recompetes, which could adversely affect their future results. Lockheed Martin has mentioned that they are facing increased competition from startups and non-traditional defense contractors. These competitors may have a lower cost structure or be able to move quickly. Additionally, they are favored, in certain cases, by procurement policy.
Reasons to invest
There are also numerous reasons to invest in Lockheed Martin. One of the reasons is their large backlog. The backlog indicates that Lockheed Martin will not be going out of business anytime soon. In 2023, Lockheed Martin achieved record orders as they grew by 7%. It has resulted in an order backlog of $161 billion, which is more than two years' worth of revenue. This record backlog provides visibility for Lockheed Martin's long-term growth. We will probably see more orders moving forward, as most NATO members are still not meeting the target of spending 2% of their GDP on defense budgets. Given the unfortunate state of the world, NATO members may be more willing to allocate funds to their defense budgets. This is supported by a statement from Secretary General Jens Stoltenberg, who has noted that NATO witnessed an "unprecedented rise" in defense spending from European Allies and Canada in 2023, with an increase of 11% in defense spending. He also added that he expects 18 allies to spend 2% of GDP on defense in 2024.
Another reason to invest is 1LMX. In late 2022, Lockheed Martin announced a 7-year program called 1LMX to transform its end-to-end business processes and systems. The goal of the program is to implement new digital tools such as automation, robotics, and factory simulations in their operations and utilize model-based engineering to accelerate the speed at which products reach the market. Furthermore, Lockheed Martin believes that 1LMX will find synergies among their four different segments and other cost-reduction opportunities that will enhance operating efficiency, thereby increasing profits. A little more than one year into the program, it has resulted in benefits such as cost reduction in their direct cost base through supply chain optimization and improved factory productivity. The 1LMX program is an ongoing initiative that should continue to enhance Lockheed Martin's profitability, while also ensuring its processes and systems remain the most advanced in the industry.
Dividends and buybacks. Lockheed Martin has a tradition of returning capital to shareholders through dividends and share buybacks. In 2023, management returned approximately $9 billion to shareholders through dividends ($3 billion) and buybacks ($6 billion). Over the past ten years, Lockheed Martin has increased its dividend by a 9,51% compounded annual growth rate, which is above the sector median of 7,56%. Lockheed Martin has also bought back shares; they have repurchased approximately 12% of the current market capitalization in the past two years. Management expects to make $4 billion in share repurchases in 2024, while also recently increasing their dividend.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 27,55, which is from the year 2023. I have selected a projected future EPS growth rate of 8%. Finbox expects EPS to grow by 8,6% in the next five years. Additionally, I have selected a projected future P/E ratio of 16, which is double the growth rate. This decision is based on Lockheed Martin's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $235,23. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Lockheed Martin at a price of $117,62 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 7.920, and capital expenditures were 1.691. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 1.184 in our calculations. The tax provision was 1.178. We have 242 outstanding shares. Hence, the calculation will be as follows: (7.920– 1.184 + 1.178) / 242 x 10 = $328,26 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Lockheed Martin's free cash flow per share at $25,11 and a growth rate of 8%, if you want to recoup your investment in 8 years, the Payback Time price is $288,45.
Conclusion
I believe that Lockheed Martin is a great company with excellent management. The company should perform well in all economic environments, which could be a valuable addition to one's portfolio. Lockheed Martin has also consistently delivered a high Return on Invested Capital (ROIC), which indicates that it is a quality company. There are some risks associated with Lockheed Martin, one of which is its dependence on the U.S. defense budget. If the U.S. cuts its defense budget as they did every year from 2011 to 2015, it will affect Lockheed Martin. Lockheed Martin is also dependent on the F-35 program, which is consistently under review. However, countries continue to buy F-35s, and there is no indication that this trend will cease in the near future. Nonetheless, having such a dependence is always a risk and something that needs to be monitored. Competition will always pose a risk for Lockheed Martin, and the growing competition from startups and non-traditional defense contractors could potentially impact Lockheed Martin in the future. However, I believe that Lockheed Martin's substantial backlog provides visibility for long-term growth, and if countries increase their defense spending, this backlog could significantly expand. The 1LMX program is expected to consistently enhance Lockheed Martin's profitability over the next five years, a prospect that I, as an investor, would value. Finally, Lockheed Martin is shareholder-friendly, as it plans to continue increasing dividends and buybacks in the future. I believe there are many things to like about Lockheed Martin, and I will buy shares if it reaches the Payback Time price of $288.
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