LMT - Lockheed And Raytheon: Hedging Against World War

• Geopolitical tensions are on the rise, as Ukraine and Taiwan divide the world's powers. We're not ruling out the possibly of a global depression, nor WW3.
• Raytheon and Lockheed Martin are set to benefit in such an environment.
• But is it too late to hedge? In the decade ahead, we project returns of 7% per annum for Raytheon and Lockheed Martin.

The Intro

As tensions build around Taiwan and Ukraine, we think it's important to ask yourself, "What's the worst-case scenario?" If China were to invade Taiwan, how would the world respond? Sanctions were placed on Russia, sending energy prices soaring and creating the conditions for a "long, cold winter" in Europe. If the same sanctions were placed on China, the consequences could be far worse; we wouldn't rule out a global depression. China is the world's largest nation in terms of trade. Companies like Apple (AAPL), Starbucks (SBUX), and Nike (NKE) are heavily exposed to China. Much of what we use on a day-to-day basis is manufactured in the country.

Nancy Pelosi visited Taiwan, in the face of a Chinese military claiming it will "not sit idly by." Meanwhile, hardheaded politicians are ruling over the world's largest countries, armed with nuclear capabilities. While it seems like the last priority, we're in the investment business. If one thinks of what type of business would do well in a world showered with war and economic hardship, one might think of the aerospace defense companies Lockheed Martin ( LMT ) and Raytheon Technologies ( RTX ). In the decade ahead, we project returns of 7% per annum.

The Economic Shield

Lockheed Martin

Lockheed makes its money through contracts, not only with the U.S. military, but with allied countries around the world:

This business relies not on the strength of the consumer, but on the strength of the government. So long as governments are not burdened financially, Lockheed's business is economically insensitive. The company grew revenue right through the global financial crisis of 2008:

Lockheed Martin makes most of its money selling military equipment such as fighter jets and missile defense systems, but is also in partnerships with NASA through its space division. Here's a breakdown of the company's segments:

Long-term Returns

Expert consensus thinks these companies will grow at enormous rates into 2024:

We think growth will slow following this uptick. Buybacks should also slow as there isn't enough cash to maintain the current pace. Looking at the industry, U.S. defense spending is projected to grow at just 3% per annum through to 2032. It's possible that international spending in this category grows faster, but the United States will need to maintain its alliances for Lockheed Martin and Raytheon to benefit. These businesses have grown revenue at 5.5% per annum since 1995:

Our 2032 price targets for Lockheed Martin and Raytheon Technologies are $655 per share and $142 per share respectively, implying returns of 7% per annum with dividends reinvested.

• We've projected Lockheed Martin and Raytheon to grow current EPS by 9% and 11.5% per annum respectively, resulting in 2032 EPS of $40.95 and $8.88. This growth is possible on the back of expanded profit margins. We've assigned a terminal multiple of 16x.

Conclusion

Using Lockheed Martin and Raytheon Technologies to hedge against world war isn't a terrible strategy, but it should yield fairly mediocre returns. The best time to buy a hedge is when nobody wants it. In hindsight, 2020 was a great time to hedge against higher oil prices. As famed investor Carl Icahn once said:

"You've got to buy them when nobody wants them, really. I mean that's the real secret. It sounds very simple, but it's very hard to do. When everybody hates it, you buy it. And when everybody wants it, you sell it to them."

We think geopolitical fears have reduced long-term returns for Lockheed Martin and Raytheon Technologies. That said, they're still a decent hedge against major conflict. We have a "hold" rating on the shares.

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