LMT - Lockheed Martin: Strong Catalysts But One Caveat

Summary

• Lockheed Martin is in a favorable position now that ongoing global threats could spread. Net sales are expected to increase from 2024 and beyond as headwinds subside.
• The future looks bright as the Defense Department's budget has increased 10% year over year to $858 billion for National Defense.
• While there are many positive catalysts for Lockheed Martin, there is still one caveat.
• Looking at analysts' earnings expectations, the share price seems reasonably valued in the near term.

Introduction

If you bought Lockheed Martin ( LMT ) shares 10 years ago, you did very well in terms of total stock return. The stock far outperformed the S&P500, with an annualized return of 21.7% over this period. Now that the stock price has risen significantly, we want to get an understanding of its potential for further growth.

As the war in Ukraine continues, defense stocks are a hot item. Lockheed Martin produces advanced combat aircraft, missiles and fire control systems, rotary and mission systems and many more. This could make Lockheed Martin an ideal candidate for your defense stock portfolio.

Lockheed Martin offers a large and growing aerospace portfolio, the company pays a good dividend and repurchases many shares. This makes it an ideal candidate for both growth and income investors. However, the stock's valuation is currently a bit on the high side, but for the near term future Lockheed Martin seems reasonably valued.

Strong Backlog And Outlook

First, we take a look at its earnings. On Jan. 24 2023, Lockheed Martin reported its results for the fourth quarter and full year 2022 . The company reported net sales of $19 billion for the fourth quarter and $66 billion for the full year, representing year-over-year growth of 7.2% and a decline of 1.6%, respectively. Non-GAAP net profit was $2.0 billion for the quarter and $7.2 billion for the full year (down 2.7%). And its free cash flow was strong for the year at $6.1 billion, and the order book rose to the record $150 billion.

The Department of Defense budget (specifically the FY '23 Omnibus spending bill) was increased by 10% year over year to $858 billion for National Defense. This allows Lockheed Martin to complete the contract for the production and delivery of up to 398 F-35s for $30 billion in lots 15 and 16, including the option for lot 17. This is a good sign for Lockheed Martin as it allows funding for various programs to enable future long-term growth.

The demand for Lockheed Martin defense systems is strong, sales in 2023 are expected to be flat compared to 202, but sales are expected to grow in 2024 and beyond as headwinds subside and the supply chain recovers.

Dividends And Share Repurchases

Lockheed Martin is well suited for both growth and income investors because the company has been increasing its dividends for many years. The dividend is currently $12 per share, representing a dividend yield of 2.53%. The dividend has grown from $4.15 in 2012 to $11.40 in 2022, representing a strong annual increase of 10.6%.

Cash flow statements show that dividend payments have increased over the past 4 years, along with strong growth in free cash flow.

Lockheed Martin is also repurchasing shares, which may contribute to the strong growth in share price. Share repurchases reduce outstanding shares and increase demand when purchased on the open market. I always look at companies that repurchases shares because they can offer both share price growth and dividend growth (because fewer shares are available). In the fourth quarter, Lockheed Martin accelerated its share repurchase program by $4 billion and so far bought about 7 million shares under that repurchase program.

As for the future, Lockheed Martin still has authorization to repurchase up to $10 billion of common stock over the next few years, which represents a high buyback yield of 8.3% and could boost the stock price and dividend per share higher.

Overall, dividend payments plus share repurchases have been slightly higher than net income lately. In 2022, Lockheed Martin nearly doubled the amount it returned to shareholders compared to its net income. Of course, this is not sustainable in the long run because it reduces their cash balance.

Net debt is down slightly from $13.3B in 2018 to $12.9B now thanks to high cash flow generation. With free cash flow of $6.2B in 2022, their net debt is easily manageable, and interest coverage is high at 13.4x times net income.

Most companies offer such generous share repurchase programs when they believe the stock is undervalued and when they have large cash reserves. And share repurchases are a tax-efficient way to return cash to shareholders. Let's look at the stock's valuation.

Stock Valuation

To understand the stock's valuation, we first look at cash and debt, as this is an important part of the stock's valuation. Since 2005, the company's enterprise value to EBIT ratio has seen ups and downs, with the ratio being at its lowest (around 6!) from 2009 to 2013. More recently, in 2022, the ratio dropped again to a value of 12, which is generally an attractive value. Now, at a value of 18.3, the stock's valuation seems historically expensive. The 3-year average quotes 14.1, so the company seems 30% overvalued.

Debt has increased somewhat recently, while there is less cash on the balance sheet. This increases the enterprise value and thus the valuation of the stock (EV/EBIT ratio).

The PE ratio is another valuation metric to gain insight in the stock's valuation. Today, the PE ratio notes 21.7, which is also a high figure compared to Lockheed Martin's historical figures. The 3-year average PE ratio is 16.7, so currently the stock seems overvalued by again... 30%.

Looking ahead, 13 analysts expect earnings per share to decrease slightly in 2023 but are expected to increase 5% in 2024. The forward PE ratio for 2024 is 16.9, indicating that the stock is valued in line with its 3-year average.

Conclusion

Lockheed Martin is in a favorable position now that ongoing global threats could spread. The company reported strong earnings for the fourth quarter and full year 2022 with a historically high order backlog of $150 billion. Net sales for the full year came in with a small decline of 1.6% and net profit for the full year was down 2.7%. The future looks bright as the Defense Department's budget has increased 10% year over year to $858 billion for National Defense. This will allow Lockheed Martin to continue to grow strongly. Net sales are expected to increase from 2024 and beyond as headwinds subside and the supply chain recovers.

Lockheed Martin pays a steadily growing dividend that currently represents a dividend yield of 2.5%. The company is also buying back shares, allowing them to increase the dividend rate year after year, and the share buybacks could also boost the stock price. While there are many positive catalysts for Lockheed Martin, there is still one caveat. The stock's valuation currently seems somewhat overvalued compared to historical figures. However, looking at analysts' earnings expectations, the share price seems reasonably valued in the near term. Because the stock is somewhat expensively valued, I put Lockheed Martin on hold.

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