LMT - Lockheed Martin: Japan's Defense Budget - A Military Game Changer?
2024-01-19 14:12:08 ET
Summary
- Japan's defense policy shift, including increased spending and relaxed arms export rules, presents a lucrative opportunity for Lockheed Martin.
- Lockheed Martin's diversified portfolio in cybersecurity, aerospace, and naval equipment positions it well to drive innovation in the Asia-Pacific defense market.
- Understanding Lockheed Martin's current and potential projects in Japan, such as the F-35 jets, will provide insights into its market penetration and growth prospects.
With Japan aggressively expanding its military budget to counter threats from China, Taiwan, North Korea, and Russia, I believe Lockheed Martin ( LMT ) is perfectly positioned to capitalize on over $8 billion in new defense contracts. I am bullish on Lockheed stock as these geopolitical tensions escalate, and I believe there's more upside to its stock price than current estimates imply.
For these reasons, I rate Lockheed Martin as a compelling "Buy" in light of these developments, and I believe that the best is yet to come for long-term investors.
Japan’s Defense Policy Shift
Japan's government has approved a record defense budget of 7.95 trillion yen ($55.9 billion) for 2024, representing a substantial 16.5% increase from the current fiscal year. This marks the tenth consecutive year of increased defense spending and is part of Japan's comprehensive Defense Buildup Program, which outlines an expansive $302 billion in defense expenditure over the five years through FY2027.
This significant increase in defense spending is driven largely by Japan's concerns over the region's increasingly volatile environment, particularly in light of the military activities and assertive postures of China, North Korea, and Russia. This defense budget addresses what Tokyo perceives as "the most severe and complex security situation since the end of World War II."
Japan's primary security focus, as outlined in its 2023 defense whitepaper, centers on China's position regarding Taiwan. Being a major non-NATO ally of the United States, Japan is anticipated to be a crucial player in the defense of Taiwan in the event of a conflict, potentially as part of a US-led coalition that could also include the Philippines and other allies. Due to Japan's proximity to Taiwan (just 1,300 miles from Tokyo to Taipei), Japan's involvement would be critical in the scenario of a Chinese invasion.
China is aware of the possibility of Japan's involvement in Taiwan's defense and has issued stark threats should Japan intervene. Most recently, in his New Year address, Chinese leader Xi Jinping's statement declaring the reunification with Taiwan as a “ historical inevitability ” has put the U.S. and her allies on high alert.
I believe the ongoing hostilities in East Asia will intensify - even if it does not lead to an outright war. But a flashpoint is inevitable. This tension is rooted in China's longstanding vow to reclaim Taiwan, a commitment dating back to 1949 when the Chinese Kuomintang nationalists fled to the island. The first Taiwan Strait skirmish followed shortly after, ultimately leading to the Sino-American Mutual Defense Treaty . However, China's window to act on Taiwan is narrowing due to internal and external factors. These include China's demographic challenges, such as its aging population and the repercussions of the one-child policy, and a strengthening independent Taiwanese identity that makes reunification by voluntary means increasingly less likely. These factors suggest a fomentating backdrop of escalating tensions, which I believe will have ripple effects across Asia.
I anticipate that Japan's progressive rearmament will catalyze a widespread increase in military preparedness across the region. This trend is expected to include U.S. allies like the Philippines and traditionally neutral countries grappling with their own issues with China, such as India, Malaysia, Vietnam, Indonesia, and all others concerned about their security status in the South China Sea. I expect these nations will increase their military budgets and capabilities in preparation for a potential conflict, which could lead to one of the most difficult, extensive, and destructive amphibious invasions in history.
Japan's approach is centered on deterrence, aiming to make any potential aggression against it unappealing from a cost-benefit perspective. This stance is rooted in Japan's post-World War II pacifist constitution, specifically Article 9 , which technically prohibits the country from maintaining a standing army (this is why Japan's military is referred to as the Japan Self-Defense Forces) or owning offensive military weapons, such as aircraft carriers or nuclear weapons. However, in practice, Japanese courts and politicians have interpreted this article to include the " collective self-defense " of its allies, which would pointedly extend to the United States and send Japan back to the Pacific theatre once more.
Lockheed Martin's Expanding Role in Japan's Defense Sector
Japan is poised to become the foremost operator of F-35 fighter jets outside the United States. Its ambitious plan involves acquiring 147 F-35s , comprising 105 F-35A and 42 F-35B models. Japan has already begun receiving its F-35As and is scheduled to get its first F-35B in 2025. Before its latest fiscal year 2024 budget request, Japan had contracts for 63 F-35As and 20 F-35Bs. The 2024 budget request allocates substantial funding for these jets: $739.3 million for eight F-35As and $862.3 million for seven F-35Bs.
This significant investment in F-35 jets is anticipated to be a major revenue source for Lockheed Martin.
Another key area of growth for the company in Japan is in the realm of missiles and hypersonic weapons. Japan's defense budget includes funding for developing and producing various missile systems, focusing on advancing hypersonic weapon technology. This encompasses ongoing research into the Type 12 missile , a land-based system launched from trucks, and efforts to acquire advanced standoff weapons from international sources. This includes the AGM-158 Joint Air-to-Surface Standoff Missile, also produced by Lockheed Martin.
For a comprehensive understanding, I've compiled a table that outlines Japan's military budget specifics , which will be useful in highlighting Lockheed Martin's contributions and roles within various budget segments.
| Budget Item | Amount in Yen | Amount in USD (approx.) |
|---|---|---|
| 0.0 | ||
| 9.8 | ||
| 124.26 | ||
| -2.22 | ||
| 0.3 | ||
| 10.1 | ||
| 128.07 | ||
| 0.77 | ||
| 0.6 | ||
| 10.4 | ||
| 131.87 | ||
| 3.76 | ||
| 0.9 | ||
| 10.7 | ||
| 135.68 | ||
| 6.76 | ||
| 1.2 | ||
| 11.0 | ||
| 139.48 | ||
| 9.75 |
The valuation analysis reveals a median upside potential of 16.38% for Lockheed Martin. The most optimistic scenario predicts a 9.73% rise in Enterprise Value with an incremental EBITDA of $1.2 billion, aligned with the 5-year median EV/EBITDA multiple of 12.68x.
To further establish its valuation, Lockheed Martin's industry peers include Northrop Grumman ( NOC ), Raytheon Technologies ( RTX ), and General Dynamics ( GD ).
| Company Name | Enterprise Value ((EV)) | Revenue Growth (Forward) | EPS Growth Diluted (Forward) | P/E GAAP (Forward) | P/E GAAP ((TTM)) | Price/Sales ((TTM)) | Net Income Margin | Return on Equity ((ROE)) | Total Debt to Equity | Dividend Yield | Dividend Growth 5 Year ((CAGR)) | Consecutive Years of Dividend Growth |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Lockheed Martin ((LMT)) | ||||||||||||
| 127.43B | ||||||||||||
| 0.80% | ||||||||||||
| 5.55% | ||||||||||||
| 16.78 | ||||||||||||
| 16.71 | ||||||||||||
| 1.71 | ||||||||||||
| 10.29% | ||||||||||||
| 65.59% | ||||||||||||
| 187.50% | ||||||||||||
| 2.75% | ||||||||||||
| 8.18% | ||||||||||||
| 21 Years | ||||||||||||
| Northrop Grumman ((NOC)) | ||||||||||||
| 85.26B | ||||||||||||
| 4.83% | ||||||||||||
| -1.83% | ||||||||||||
| 21.13 | ||||||||||||
| 15.65 | ||||||||||||
| 1.88 | ||||||||||||
| 12.07% | ||||||||||||
| 31.27% | ||||||||||||
| 97.90% | ||||||||||||
| 1.57% | ||||||||||||
| 9.33% | ||||||||||||
| 20 Years | ||||||||||||
| Raytheon Technologies ((RTX)) | ||||||||||||
| 155.64B | ||||||||||||
| 7.13% | ||||||||||||
| 7.41% | ||||||||||||
| 39.54 | ||||||||||||
| 39.33 | ||||||||||||
| 1.86 | ||||||||||||
| 4.76% | ||||||||||||
| 4.72% | ||||||||||||
| 51.63% | ||||||||||||
| 2.76% | ||||||||||||
| 5.39% | ||||||||||||
| 30 Years | ||||||||||||
| General Dynamics ((GD)) | ||||||||||||
| 77.92B | ||||||||||||
| 6.12% | ||||||||||||
| 8.98% | ||||||||||||
| 20.55 | ||||||||||||
| 20.93 | ||||||||||||
| 1.65 | ||||||||||||
| 7.97% | ||||||||||||
| 17.56% | ||||||||||||
| 55.10% | ||||||||||||
| 2.11% | ||||||||||||
| 7.54% | ||||||||||||
| 29 Years | ||||||||||||
| Average | ||||||||||||
| 111.56B | ||||||||||||
| 4.72% | ||||||||||||
| 5.03% | ||||||||||||
| - | ||||||||||||
| - | ||||||||||||
| - | ||||||||||||
| 8.77% | ||||||||||||
| 29.78% | ||||||||||||
| 98.03% | ||||||||||||
| 2.30% | ||||||||||||
| 7.61% | ||||||||||||
| 25 Years | ||||||||||||
| Median | ||||||||||||
| 106.34B | ||||||||||||
| 5.48% | ||||||||||||
| 6.48% | ||||||||||||
| 20.84 | ||||||||||||
| 18.82 | ||||||||||||
| 1.785 | ||||||||||||
| 9.13% | ||||||||||||
| 24.42% | ||||||||||||
| 76.50% | ||||||||||||
| 2.43% | ||||||||||||
| 7.86% | ||||||||||||
| 25 Years |
Lockheed excels in profitability with a net income margin of 10.29% and an impressive Return on Equity ('ROE') of 65.59%, surpassing its peer average.
But what stands out to me is its dividend strength. With over 30 years before retirement, my core portfolio consists of dividend growth companies. Therefore, I'm much less concerned about my immediate dividend yield than I am about dividend growth since the compounding effect has more time to run.
I intend to make Lockheed Martin a significant part of my portfolio. A large reason why can be seen below: it has a 2.76% forward yield, a $12.60 annual payout, a 43.29% payout ratio, an 8.18% growth rate over five years, and a 21-year history of dividend growth. All of these factors, apart from one, are exceptional bar its dividend yield, but this is less important for investors chasing dividend growth and not immediate income.
However, capital appreciation is equally important for long-term dividend growth investors, which Lockheed Martin has proven convincingly. Since it went public, its total return level significantly outperformed the SPDR S&P 500 ETF Trust and Invesco QQQ Trust. It then gives DGI investors that rare blend between income growth and capital appreciation, a massive competitive moat, and an expanding backdrop of geopolitical tensions to keep its products turning over.
Meanwhile, the growth and returns continued to flow to investors last quarter. The company authorized a fourth-quarter dividend of $3.15 per share, up from $3.00 in the third quarter. The company board also authorized an additional $6 billion for the share repurchase program, which was in addition to the $7 billion remaining that was previously authorized.
Its order backlog at the end of the quarter was $156 billion. This reflects strong ongoing demand for its products, particularly its aircraft. The total backlog amount stood at 391 aircraft waiting to be delivered.
Part of its attractiveness to me is that about 75% of total sales came from the U.S. Government last quarter. Having such a financially stable customer means cash flows tend to hold up even in challenging times. Its contracts with other developed countries also give it excellent stability.
The company is positioning itself in attractive, high-growth areas such as cybersecurity and advanced technologies. These growth drivers will make it an even more compelling pick, and I believe we can expect the gains seen to continue flowing back to shareholders.
Risks
Although unlikely, the reliance on geopolitical uncertainties presents risks. Should regional tensions de-escalate or diplomatic solutions gain traction, the expected boost in defense spending and procurement could soften, potentially impacting Lockheed Martin's projected revenues from this market.
Another significant risk factor is the potential disruption to Lockheed Martin's vast supply chain. The company relies on thousands of domestic and international suppliers and subcontractors. Geopolitical conflicts, trade disputes, or production issues could cause delays or shortages, impacting Lockheed's ability to meet delivery timelines.
Conclusion
Given the substantial revenue growth potential from Japan's increasing defense investments and escalating geopolitical tensions, I maintain my positive stance and "Buy" recommendation for Lockheed Martin stock, as initially stated in my introduction.
Considering East Asia's volatile and tense situation, I believe that Lockheed Martin's stock price will appreciate more rapidly than the general analyst consensus suggests.
Also, I feel the potential gains from Japan's defense contracts are not fully reflected in Lockheed Martin's current valuation. Additionally, the emergence of new conflict zones and potential hotspots worldwide will drive demand further, contributing to the company's growing value.
For further details see:
Lockheed Martin: Japan's Defense Budget - A Military Game Changer?