This analysis is about Lockheed Martin which operates in the defense industry. In this analysis, I will not discuss ethical issues associated with this industry. Which industries one invests in is ultimately a personal decision. For this reason, this analysis will focus on the return potential of Lockheed Martin´s stock, without making any moral judgements. Whether Lockheed Martin in general meets your expectations is up to you.
|Lockeed martin stock|
|Industry||Aerospace & Defense|
|Market cap.||106.9 billion $|
|Stock Price||382.04 USD|
|Dividend stability||0.98 of max. 1.0|
|Earnings stability||0.94 of max. 1.0|
Lockheed Martin has blessed its shareholders with high returns in recent years. Those who bought the stock 5 years ago have since raked in a 12 percent annual return from price gains and dividends. For the past 10 years, the annual return is even higher (19 percent). Despite these excellent historical figures and the high quality of the business model, the stock price has still not fully recovered to its previous high prior the Corona-Crash. In this analysis, we will dive into the business of Lockheed Martin and determine whether the stock presents a good investment opportunity right now.
Lockheed Martin is a global defense, aerospace and technology company. Its operations are grouped into the following four segments (page 4): Aeronautics, Missiles and Fire Control, Rotary and Mission Systems, and Space.
This segment is involved in the development, production and maintenance of military aircraft (helicopters, airplanes) and unmanned air vehicles (drones). The arguably best-known product from this business unit is the F-35 fighter jet. This is by far the largest segment of the company as it is responsible for 40 percent of revenues.
This business unit develops air and missile defense systems, short-range missiles, air-to-ground weapon systems and fire control systems. Ground vehicles are also part of the product portfolio. This segment is responsible for 17 percent of total revenues.
Lockheed Martin also develops helicopters, surface ships, land-based missile defense systems, radar systems, and more. This segment accounts for 25 percent of total revenues.
As the name suggests, this segment is comprised of all products related to space, such as satellites and space transportation systems. It is responsible for 18 percent of revenues.
Lockheed Martin has proven its ability to achieve both high and consistent earnings growth over many years. Over the past 5 years alone, earnings per share have more than doubled. During the past 10 years, earnings per share have grown by an average of 13 percent per year. In my opinion, this is an impressive achievement for a company of this size (USD 66 billion in revenue). Equally remarkable is the stability of the business model. As a defense contractor, Lockheed Martin benefits from the long-term supply contracts that are common in this industry. As a result, the company secures customers for its products far into the future. However, this long-term commitment is also necessary because the development of products like a fighter jet costs a lot of money. The development costs of the F-35 jet have been estimated at around USD 45 billion. The long-term contracts as well as the financial backing by the government, make such projects lucrative despite the initially high development cost. The development of the F-35 jet was financially backed by a large number of countries which in turn received order priorities from Lockheed Martin.
Another boost to Lockheed Martins revenues is the rising US defense budget. According to Statista, US defense spending is expected to rise from the current USD 733 billion to USD 915 billion until 2031. However, the company’s dependence on the US is also a risk. In 2020, the US government was responsible for 74 percent of Lockheed Martin’s revenues (page 85). Generating three-quarters of revenues from a single customer would be considered a huge risk for most companies.
On top of that, there has been increased political and social crisitism of the magnitute of the defense spending. A frequently brought up argument is that a reduction in military spending could be used for social programs instead. Although I can see the merit in these claims, I do not expect the defense spending to materially decrease in the near future. President Biden recently presented the fiscal budget for 2022, in which he requested a 1.6 percent increase in defense spending.
Lockheed Martin’s business model is extremely crisis-proof due to the long-term contracts and the high annual defense spending of the United States. These factors ensure predictable and stable revenues even in years in which the general economy is not doing well. As you can see in the following chart, the financial crisis of 2008 and the Corona crisis since 2020 have not affected Lockheed Martin’s earnings at all, while companies in other industries have had to suffer major financial hardships.
There are three reasons for the continuous increase in profits:
A part of the increase in earnings has come from topline growth. Revenues have grown by an average of close to 4 percent per year over the last 10 years and by about 8 percent annually over the last 5 years. Under normal circumstances (stable margins), higher revenues also lead to higher profits. However, if you compare the growth rates of revenues and profits, you will notice that the revenue growth cannot be solely responsible for the increase in profit.
In addition to growing revenues, Lockheed Martin has also increased its margins. Over the last 5 years, the operating margin increased from 11.8 to 13.4 percent and the net margin increased from 7.8 to 10.6 percent. Higher margins translate into higher profits on both existing revenues as well as any additional revenue that comes from future growth.
The third contributor to Lockheed Martin’s earnings per share growth are stock buybacks. The company is aggressively buying back its own stock. At its peak in 2002, Lockheed Martin had 452 million shares outstanding. This number has since been brought down to 280 million shares which is a reduction of almost 40 percent! Buybacks boost a company’s earnings per share since the earnings are now being distributed among fewer shares which increases the amount of profit each share is entitled to.
Dividendstock.cash shows you which part of a company’s earnings growth can be attributed to organic factors and which portion is coming from buybacks. The following chart shows that Lockheed Martin’s earnings growth is predominantly organic, despite the aggressive buybacks.
If you just focus on the growth numbers themselves, it is irrelevant whether earnings growth is achieved through organic factors or buybacks. However, organic growth indicates a healthy and functioning business model. This is important because buybacks ultimately have to be financed by the daily operations of the company.
Like other US companies, Lockheed Martin pays a quarterly dividend to its shareholders. These quarterly payments totaled USD 10.20 per share in the last 12 months. This translates into a current divdend yield of 2.6 percent, in line with the average of the past 12 months, but slightly below the 10-year average of 3 percent.
The Dividend Turbo shows you the historical dividend yields of Lockheed Martin. What you will notice is that the yield of the Lockheed Martin stock has been mostly stable with few fluctuations over the years. Judging by the current dividend yield in comparison to its historical averages, the stock appears fairly valued when measured against the average of the last 12 months. On a 10-year time frame, however, the stock appears slightly overvalued.
Just as important as the size of the dividend yield are its safety and growth potential. In terms of safety, Lockheed Martin looks strong at first glance. The dividend has been increased for 18 years straight and has not been reduced for 35 years. In addition, shareholders have enjoyed double-digit dividend growth. Over the last 10 years, the dividend grew by an average of 13 percent per year. With such high growth rates, even an initially low dividend yield quickly grows to a sizable amount, provided this growth continues in the future. To assess whether this will be the case, let us now look at the important factors that ensure a safe and growing dividend.
The indebtedness is an important factor to consider when determining dividend safety. Interest must always be serviced first, thus reducing the profit left over for dividend payments. Fortunately, Lockheed Martin is not too heavily indebted. While its total debt sits at USD 45 billion, only USD 12 billion of that debt interest bearing, the remainder being non interest bearing.
As its name suggests, non interest bearing debt does not carry interest. This includes, but is not limited to, outstanding invoices (accounts payable) and outstanding salary payments (page 3).
Since only a third of Lockheed Martin’s debt is interest bearing, the resulting interest burden is relatively low. For the last fiscal year, the company had to pay USD 591 million in interest on its debt which was just under 7 percent of the operating income during that year. For a company with stable and growing earnings, this is easily managable. Moreover, the share of the operating income used for interest payments has been declining for years. In 2018, 9 percent of the operating profit had to be used to service the debt.
There are two reasons for this decline. First, Lockheed Martin has reduced its interest bearing debt by USD 2 billion since 2018, down from USD14 billion to USD 12 billion. The second reason is the increase in operating income, which grew from USD 7.3 billion in 2018 to USD 8.6 billion in 2020 (page 67).
The amortization power of Lockheed Martin, on the other hand, does not look as good at first glance. Although the company usually generates high surpluses, the amortization power has slipped into negative territory twice during the last 10 years. This happened in 2012 and 2018.
In both years, the reason for this occurrence was a change in the so-called working capital, as well as contributions to the pension benefit plans of the employees (see Annual Report 2012 page 58 and Annual Report 2018 page 61). Working capital is the difference between current assets and current liabilities. When a company increases its inventory, it ties up cash and reduces cash flow by the amount of the price of the goods purchased. The same effect occurs when other current assets increase. If, for example, outstanding trade receivables increase, the company has generated sales without having received any cash inflow from these sales. This cash is tied up in outstanding receivables and is not released until those invoices have been paid. In 2018, Lockheed Martin’s outstanding receivables increased by USD 1.6 billion. On top of that was a USD 3.6 billion charge to fund the employee pension benefits. On the liabilities side, this effect is reversed. If liabilities increase, the company has received an inflow of cash or goods without having paid for the yet, and cash flow increases. In order to reduce these liabilities again at a later date, a cash outflow has to take place.
Working capital changes are usually normal business events that you don’t have to worry about. Apart from that, the cash flow surpluses of Lockheed Martin are significantly higher in all of the other years and easily compensate for the few negative years. Moreover, Lockheed Martin generates extremely stable profits, a fact that speaks for the strength of the business model. In general, you can keep in mind that cash flows tend to fluctuate more heavily than a company’s profits. For example, large investments can lead to a negative amortization power within a given year. As long as these fluctations are short-term occurrences and are not caused by a deterioration in the business model, they are usually negligible.
Another import safety factor is the payout ratio. Very high payout ratios can be an indication of an unsustainable dividend. This is especially true for companies which operate in cyclical markets where earnings can fluctuate heavily between years and can even drop significantly very quickly. This can pose a threat to the dividend if the payout ratio is already stretched. For example, at a payout ratio of 90 percent, a drop in earnings larger than 10 percent will already put the company in a position where the dividend cannot fully be financed by the earnings alone. If the company does not have sufficient cash on hand, it will either have to borrow money to fund the dividend or cut it. Low payout ratios, on the other hand, offer more safety against dividend cuts and give the company more room to maneuver. Fortunately, Lockheed Martin does not operate in a cyclical market and has stable earnings and cashflows. Furthermore, the payout ratio of Lockheed Martin is on the lower side, currently sitting at just 41 percent which is a conservative level.
This leaves the company with sufficient funds for new investments, which in turn drive further growth. Thanks to this growth, Lockheed Martin can then increase its dividend without increasing the payout ratio.
In summary, I believe Lockheed Martin’s dividend is safe. The company has no apparent weaknesses that could jeopardize the dividend. I therefore expect that the dividend will continue to rise in the future.
Lockheed Martin is currently trading at a price of USD 387 per share. Judging by the P/E ratio of 16, the stock does not appear particularly expensive at first glance.
To value the stock, I use the fair values for the earnings and dividend and select the past 10 years as the time frame over which the historic averages are calculated. The results differ slightly between the two metrics. According to the fair value for the earnings, the Lockheed Martin stock is currently fairly valued. On the other hand, the dividend fair value indicates a slight overvaluation by 16 percent. However, after including the predicted dividend hikes in the near future, the fair value closely approaches the current stock price.
Based on these results, I consider the Lockheed Martin stock to be fairly valued. Over the past 10 years, the stock has been overvalued, as measured by its fair values, most of the time. These periods of overvaluation have been quite extreme in several cases and have often persisted for extended periods of time. Times in which the stock has been fairly valued or even undervalued have been rare. For this reason, I consider the Lockheed Martin stock to be attractive at this price point despite it “only” being fairly valued, as the stock still offers a better entry opportunity than it did for the most part of the past couple of years.
The Lockheed Martin stock offers precisely what long-term investors are looking for: a stable business model with strong and sustainable profit growth and a safe dividend. Despite the high quality, the stock is not too expensive in my opinion. Quality stocks rarely come cheap, and as I have shown you in this analysis, the Lockheed Martin stock has been significantly more expensive (as measured by its fair values) for most of the past few years. I therefore view the current price as a good entry point, either for a lump-sum investment or a savings plan.
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