LMT - Lockheed Martin Is A Beneficiary Of Geopolitical Tensions

2023-06-21 15:56:21 ET

Summary

• Lockheed Martin is likely to continue outperforming the market due to increasing defense budgets and the geopolitical situation.
• The company offers a moat-like business model, increasing dividends, and substantial share buybacks.
• Risks include global supply chain issues, talent shortages, and competition in the aerospace and defense industry.

Investment Thesis

Lockheed Martin ( LMT ) has outperformed the market already in the past decades, and I think the chances are high that this will continue. Although this year's sales YoY are expected to remain constant, the company is highly profitable and uses the money for increasing dividends and share buybacks. Given the geopolitical situation, I am surprised that the current valuation is not even higher.

Lockheed Is a Beneficiary of Higher Defense Budgets

For 2023 the budget is expected to be $817B, which is 4.6% more than last year and $45B more than " originally requested to counter the effects of inflation and to accelerate the implementation of the National Defense Strategy." In the long run, the graph of the US defense budget looks like a great stock.

One difference compared to the past is that European countries are increasing their budgets and not only Americans. There are also European defense companies that will get a piece of the pie, but especially in the area of fighter jets, a lot will end up at Lockheed.

The turnaround since Russia’s Feb. 24 invasion of Ukraine has been nothing less than stunning, to the point that six NATO members have now pledged defense increases of $133 billion so far; militarily neutral Sweden has also pledged an increase. The first to make a 180° turnaround was Germany. Just four days after Russia’s invasion began, Chancellor Olaf Scholz announced his government would ramp up its defense spending in 2022 alone by €100 billion ($112 billion) taking defense spending from 1.53% of GDP to above 2%.

Breaking Defense

In addition, not only is there the general rearmament, but the weapons already given to Ukraine have significantly reduced Western stockpiles of weapons - to the point that several European countries say their stockpiles are almost empty .

Reuters notes that Germany alone was €20 billion short of reaching the NATO target before the invasion? and that shortages are seen in battle-decisive munitions: 155 mm shells used in howitzers, HIMARS missiles, and ammunition for air defense systems like IRIS-T, and Patriot. The HIMARS system is made by Lockheed, and they also produce PAC-3 missiles for the Patriot system.

I have tried to understand the war's development and origin from both standpoints. Looking at the words and actions, it seems that the West wants to escalate further, diplomatic relations are virtually at a standstill, and there are no attempts toward peace negotiations. Therefore, it seems to me quite likely that the war could drag on for another year or more and that weapons will continue to be thrown onto the battlefield. This is the situation now, and as investors, we can't change it, but at least we can profit from it.

Even if the Ukraine conflict ends, the USA will concentrate more on the Pacific because there lurks the biggest challenger of the US hegemony position. This is also a change from the past: for decades, there was a military challenger in the form of the Soviet Union but no economic one. That has changed, and at the moment, unfortunately, it looks like we are witnessing a new split between East and West, as well as a new arms race.

The near peer threats posed by China and the Russian invasion of Ukraine is driving the national defense strategy and has created added demand for Lockheed Martin's advanced effective solutions. Key highlights include the procurement of 83 F-35 aircraft continued expansion in classified programs and an increase in requested funding for munitions.

Q1 2023 earnings call

Financial Progress & Trends

First, a short overview over a longer period for revenues, expenses, and net income.

This chart shows that sales are rising, but it looks like net income is increasing only slightly. However, if we look at the earnings per share, it seems more positive.

The margin tends to move sideways. However, it is not a software-based scalable business, so you cannot expect constant margin improvement.

Over a long period, the stock has significantly outperformed the S&P500. Both in terms of price return, i.e., without dividends and total return with dividends.

Valuation & Outlook

The company is currently valued at an enterprise value of $129B. The market cap is $116B, and the total debt is relatively low, with $16B. Currently, the valuation level is higher than in the past years. However, if we take the forward P/E ratio of 17, the valuation is reasonable. That is astonishing, given the probably higher demand for weapons and new research.

Another comparison with the historical figures is the dividend yield. We can use this comparison since the payout ratio has not increased significantly. Furthermore, the dividend increase was 8.5% per year over the last five years.

Although, according to the 2023 outlook, this year's results are expected to remain almost constant compared to the previous year in terms of revenue and EPS. But in the long term, it remains that the West is currently emptying its weapons stockpiles and needs to replenish here. Moreover, there is a considerable need for research in areas where, for example, Russia is ahead of the West.

A few of the company's notable accomplishments during the quarter included securing a contract for the first United States sea-based hypersonic missile program.

Q1 results

Risks

The company's services and products are essential to the defense and war-fighting capabilities of the USA and NATO countries. Nevertheless, there is no business without risk.

Global supply chain issues have risen significantly in recent years, also affecting the aerospace and defense industries. These disruptions can cause product production and delivery delays, affecting revenues and profitability. In addition, the U.S. is dependent on its largest rivals for some of its critical supply chain components. Even Lockheed writes about these risks:

(...) trade policies or sanctions (including Chinese sanctions on the company or its suppliers, teammates or partners, U.S. Government sanctions on Türkish entities and persons, and potential indirect effects of sanctions on Russia to the company's supply chain)

Q1 results

Furthermore, the aerospace and defense industry requires a highly skilled workforce. However, there is a risk of talent shortages in this sector. Another risk is competition. The future of warfare will likely be different than it has been: more automation, more drones, robots, and AI. It is possible that other companies will create more innovative products here that could replace Lockheed Martin's products.

Share Dilution, Insider Trades & SBCs

For me, these three things are standard checks I make in every article, as excessive stock dilution and stock-based compensation can put us, shareholders, at a disadvantage. In addition, insider trades sometimes contain valuable info about the confidence of management itself. SBCs are very low, especially compared to some Silicon Valley tech companies. In addition, there are significant buybacks; in the last two years alone, the number of outstanding shares has decreased by 10%.

These are all insider trades in the last six months, there were a few sales, but they are hardly worth mentioning, given the market cap.

Conclusion

All in all, the company offers everything investors want from value stocks: Long-term outperformance versus the market, a moat-like business model, increasing dividends, substantial share buybacks, and a currently reasonable valuation. Add to that a general tailwind from the geopolitical situation that will most likely last for years. I believe the chances are excellent that the outperformance compared to the market will continue.

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