Lockheed Martin: Is it time to get on board?
Opdateret: 7. aug.
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 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. If you want to buy shares or fractional shares in Lockheed Martin, you can do so at eToro.
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 2022), Rotary and Missions Systems (accounting for 24% of net sales in 2022), Space (accounting for 18% of net sales in 2022), and Missiles and Fire Control (accounting for 17% of net sales in 2022). The highest operating margin is Missiles and Fire Control, with a margin of 14.4%. It is followed by Aeronautics (10,6% operating margin), Rotary and Mission Systems (10.4% operating margin), and Space (9,1% operating margin). Lockheed Martin is the largest contractor of the U.S. Department of Defense, having been awarded 11,1% of total contract funds in 2022. The runner-up, on the other hand, was awarded 6,1%. The high barriers to entry in the defense industry, along with long-term contracts, mean that Lockheed Martin has a switching moat. Later, we will investigate the numbers, but let us first take a look at their management.
Their CEO is James Taiclet. He was appointed in 2020, so it is not possible to evaluate how he has performed at Lockheed Martin. However, it is possible to investigate his credentials. James Taiclet is 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. Prior to being announced as the CEO of Lockheed Martin, he served as the CEO at American Tower. Under James Taiclet's leadership, American Tower went from almost being delisted from the Stock Exchange and having a market cap of $2 billion to becoming a global player with assets in 19 countries and a market cap 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. James Taiclet has demonstrated exceptional managerial skills, along with a wealth of experience in aerospace operations and international relations.
I believe that Lockheed Martin has a strong competitive advantage. I really like the management as well. Now, let us examine the numbers to determine if Lockheed Martin meets our criteria for having 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 a 10-year history, with all the numbers being above 10% in each year. Lockheed Martin has consistently delivered a fantastic return on invested capital (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 maintains a ROIC above 20%, there is hardly anything to worry about. I would love to invest in a company that has consistently delivered a return on invested capital (ROIC) like this.
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 percentage growth year over year. Overall, the numbers are a bit mixed, and it is not surprising to see 2017 being the year with the lowest equity, as it was also the year with the lowest ROIC. Some years are affected by acquisitions, such as 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 will investigate the free cash flow. In short, free cash flow refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use the margin to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. Lockheed Martin has consistently generated strong free cash flow over the years, with few exceptions. Thus, it demonstrates the resilience of Lockheed Martin's business.
Another important aspect to consider is the level of debt, and it is crucial to determine whether a business has a manageable debt that can be repaid within a period of 3 years. We do this 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 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.
Based on the financial figures and debt, Lockheed Martin appears to be a promising company for investment. However, all investments have some risks, and Lockheed Martin is no exception. Depending on the U.S. defense budget. Lockheed Martin is the largest contractor for the U.S. Department of Defense. Hence, they are highly dependent on the U.S. defense budget. While national defense has historically been one of the top priorities of any U.S. government, in 2023 the defense budget was increased by 10%. However, there are no guarantees 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 a cut to the defense budget, 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 contracts with suppliers. However, management also mentioned that in the current environment, it is hard to negotiate long-term fixed-price contracts, and that they are being squeezed by both customers and suppliers. It means that the new contract that Lockheed Martin signs may not be as favorable as previously, which could have an impact on margins moving forward. The F-35 program represents a significant portion 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 decide 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. However, at the end of 2022, there was an issue with deliveries that resulted in a pause in flight operations, which in turn affected deliveries. It didn't affect the program, but when one program represents such a significant portion of the revenue, it poses a risk.
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 2022, Lockheed Martin achieved record orders as they grew by 11%. It has resulted in an order backlog of $150 billion, which is more than two years' worth of revenue. 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 the defense budget. Given the unfortunate state of the world, NATO members may be more willing to allocate funds to their defense budgets. Furthermore, the NATO alliance has already declared that they will increase their military budget by 25,8 %. Another reason to invest is 1LMX. Lockheed Martin has 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 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 between their four different segments and other cost-reduction opportunities that will increase operating efficiency, thereby increasing profits. Dividends and buybacks. Lockheed Martin has a tradition of returning capital to shareholders through dividends and share buybacks. In 2022, management returned approximately $11 billion to shareholders through dividends and buybacks. Lockheed Martin has increased its dividend over the past 20 years, while also repurchasing 20% of its outstanding shares in recent decades. We will likely see Lockheed Martin continue to raise their dividend, and they still have $10 billion remaining in their share repurchase program.
I perform three different calculations that I learned at a Phil Town seminar. 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 21,66 in 2022. I chose an estimated future EPS growth rate of 8% (management believes free cash flow will grow by mid-single digits, but margins should improve). I also selected an estimated future PE of 16 (which is double the growth rate, as the historical PE for Lockheed Martin has been higher). Additionally, we have already established a minimum acceptable return rate of 15%. Doing the calculations using the formula, we arrive at the sticker price (also known as fair value or intrinsic value) of $184,94 and we want to have a margin of safety of 50%, we will divide it by 2. This means that we want to purchase Lockheed Martin at a price of $92,47 (or lower, of course) if we use the Margin of Safety price.
The second calculation is called the Ten Cap price. The rate of return that an owner of a company (or stock) receives on the purchase price of the company is essentially its return on investment. The return should be at least 10% annually, and I calculate it as follows: The operating cash flow last year was 7.802. The capital expenditures were 1.670. I tried to look through their annual report to see how much of the capital expenditures were used for maintenance. I couldn't find it, but as a rule of thumb, you can expect 70% of the capital expenditures to be used for maintenance. This means that we will use 1.169 in our further calculations. The tax provision was 948. We have 254 outstanding shares. Hence, the calculation will be as follows: (7.802 - 1.670 + 948) / 254 x 10 = $278,74 in Ten Cap price.
The final calculation is called 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 23,40 and a growth rate of 8%, if you want to recoup your purchase in 8 years, the Payback Time price is $268,81.
I believe that Lockheed Martin is a great company with excellent management. The company should perform well in all economic environments, which is something that I would add to my portfolio. Lockheed Martin has also consistently delivered a high ROIC, which indicates that it is a quality company. There are some risks associated with the potential cut to the U.S. defense budget, but it is likely to be only temporary. Therefore, I am not overly concerned about it. New contracts could potentially impact margins. However, if Lockheed Martin successfully delivers on 1LMX, margins are expected to increase. Lockheed Martin has a substantial backlog, which implies that even if government budgets become more constrained worldwide, it should not significantly impact the company's operations. I was surprised to learn that Lockheed Martin has reduced its shares outstanding by 20% over the last decade. I believe it shows that management is friendly towards shareholders. I would love to add Lockheed Martin to the portfolio at the right price. If Lockheed Martin drops to $278,74, which is the Ten Cap price, I will definitely be a buyer. I may even add it at a higher price, even though it means I will receive a discount lower than 50%.
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