LMT - Lockheed Martin: Wait For A Better Entry Point

2023-04-04 00:55:53 ET

Summary

• Lockheed Martin has been posting flattish sales for a while now.
• Lack of operational growth should end later this year as the order backlog keeps growing.
• Investors have seen modest growth on a per-share basis on the back of continued share buybacks.
• I am cautious on Lockheed here at a 21 times multiple, as I require a bit more appeal before getting upbeat on the shares.

Shares of Lockheed Martin ( LMT ) have been trading stagnant in recent years. Since the start of the pandemic shares have largely traded around the $400 mark, marking multi-year consolidation. This came after the company was just a $100 stock in 2013 which broke out to $300 in the time frame of a few years, after a massive re-rating by investors.

Some Perspective

As mentioned above, defense stocks (including Lockheed Martin) at large have seen huge share price advancement during the 2010s as valuations moved from non-demanding multiples to market valuations, or even higher in the years following.

Over the past decade, Lockheed has seen modest growth, having grown sales from $45 billion to $65 billion, growing at a GDP+ rate, while growing operating margins a bit further to low double digit territory. In the meantime the company retired nearly one in every five shares outstanding, pushing up revenues and earnings growth on a per-share basis, but by far the biggest driver behind the shares has been valuation multiple inflation.

The company reported sales of $66 billion in 2022, reporting operating profits of $7.2 billion (for margins of 11%) in the process. The backbone and largest segment of the company is the $27 billion aeronautics business which posted sales of 10% and change.

The rotary and mission systems generated $16 billion in sales and similar +10% margin profile. The missiles and fire control business generated $11 billion in sales and is a bit more profitable with margins posted at 14%. The space segment is $11 billion large, yet its 9% margins are the lowest among all segments.

The Numbers

For the year 2022, Lockheed saw a modest decline in sales with revenues down from $67.0 billion to $66.0 billion as consolidated operating profits fell from $9.1 billion to $8.3 billion, resulting in net earnings falling from $6.3 billion to $5.7 billion, as earnings fell just a dollar to $21.66 per share amidst continued buybacks. The company actually cut the share count by 6% to 258 million shares, limiting the impact of lower earnings on a per-share basis.

The company has increased its net debt load to about $13 billion, which is ironically is due to a failed M&A attempt (elaborated on further) yet it remains very manageable as EBITDA trends around ten billion here, resulting in a modest 1.3 times leverage ratio.

Given that the world has become a more unsafe place in 2022, the outlook for 2023 is not particularly convincing. Despite anticipated secular growth and inflationary pressures, sales are seen flattish between $65 and $66 billion. Despite this, the company sees earnings between $26.60 and $26.90 per share. The company actually posted adjusted earnings of $27.23 per share in 2022, with most of the difference coming from pension settlement charges, which I am not too happy to adjust for.

Hence, we see flattish operational performance with earnings seen around $22-$23 per share in normal conditions, translating into premium multiples vs the market multiple. After all, at $472 per share the company trades at 20–21 times forward earnings.

A Blocked Event - Limiting Industry Consolidation

As said above, Lockheed has been taking on some leverage which ironically has been the result of a quicker pace of share buybacks, mostly as the business was halted by regulators in its attempt to further grow the business.

It is a bit of old new but relevant nonetheless. In February of last year news broke that the FTC sued to block the $4.4 billion deal to acquire Aerojet Rocketdyne Holdings, being the last independent supplier of mission propulsion systems. This comes on the back of the fact that the agency believes that rival defense contractors will be harmed if the deal goes through, after consolidation in the defense sector has gone a long way in recent years, perhaps too far for the taste of regulators.

Fairly Valued

With further industry consolidation seeing pushback from regulators with regard to Lockheed, heavy lifting will have to be done in an organic manner. Similar observations likely apply to the likes of Raytheon ( RTX ) , Boeing ( BA ) , Northrop Grumman ( NOC ) as well.

The group at large trades at largely similar sales multiples and earnings multiples (although earnings can be lumpy, certainly GAAP numbers), although not really comparable given the different focus areas of all these business (which differ). Furthermore, each of these businesses face issues, in case of Lockheed being the F35 program, among others.

And Now?

The truth is that despite the stable and stagnant operating performance, is that underlying trends have been positive. The company reported an order backlog of $150 billion, sufficient to generate over 2 years of revenues at the current rate, as the company posted a book-to-bill ratio of 1.2 times last year.

This should bode well for the second half of 2023, and into 2024, especially as NATO members are being pushed to increase defense spending towards 2.0% of GDP.

The reality is that shares look a bit pricey to me at current levels as LMT stock traded with a $300+ handle as recent as September, now trading at $472 per share. Reality is that amidst modest leverage I am happy to buy shares at a market multiple of about 18 times earnings, which works down to a $400 entry point with earnings power pegged around $22 per share which is a long way off from current levels.

That said, shares have seen some volatility in recent years, often not in line with the market movements, making me a patient buyer of the shares if they come back to less demanding valuation multiples.

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