Lockheed Loves Conflic

Defense stocks are getting a boost as the conflict between Russia and Ukraine continues.

Amongst the Aerospace & Defense stocks, we found Lockheed Martin particularly interesting.

While it didn’t garner as many searches as Boeing, which continues to be a hot topic and not for good reasons, it displayed some pretty strong fundamentals including a forward P/E ratio of 15.43x and a forward price to cash flow ratio of 12.92x

Plus, we found that while the 10-year average revenue growth for the company runs at 3.73%, the 5-year average is above 7%.

And the company has managed to improve margins over the past year despite cost pressures.

With conflict at the forefront of folks’ minds, we expect it could lead to higher defense spending, especially in European countries. That comes in addition to strong fundamentals.

Here’s our analysis.

Lockheed’s Business

Lockheed Martin is the largest defense contractor in the world. Period.

The company focuses on defense, space, intelligence, homeland security, and IT including cybersecurity.

In 2020, 71% of the company’s sales were from the U.S. government including 61% from the Department of Defense. 28% of sales came from international customers, with the remaining 1% from U.S. commercial and other customers.

The company operates through the following four business segments:

RMS – Rotary missile systems – This segment includes high profile programs such as the Aegis Combat System, Littoral Combat Ship, MH-60 helicopter avionics, as well as military and commercial orders.

MFC – Missiles and fire control – MFC includes programs such as the Terminal High Altitude Area Defense System, Joint Light Tactical Vehicle, PAC-3 Missiles, as well as logistics and other technical services.

Aeronautics – The largest segment for the company is engaged in the design, research, development, integration, production, and support of advanced military aircraft and related activities.

Space – Space Systems is engaged in the design, development, engineering, and production of commercial and military space systems.

Lockheed recently tried and failed to acquire Aerojet Rocketdyne. Unfortunately, the FTC sued to block the deal in late January, and by mid-February, Lockheed abandoned the deal.

Financials

Over the last decade, Lockheed has managed to improve gross margins by 50% while increasing revenues 42.1%.

This combination drove shareholder value in the form of stock buybacks along with a consistent dividend payout.

Despite heavy capital spending, free cash flow managed to climb nearly every year except 2018.

2021’s free cash flow of $7.7 billion is more than 12x greater than it was in 2012. That’s a massive improvement and a boon to shareholders.

Management expects to beat these results in 2022 with more than $7.9 billion in free cash flow despite slightly lower overall sales.

With a forward forecast of $26.7 EPS, that gives the company a forward P/E ratio of 15.43x.

Valuation

When we matched up Lockheed’s valuation measures against its competitors from our search list, we found compelling reasons to choose this stock over its peers.

For starters, Lockheed has the best forward ratios across all the different measures.

Plus, it has the lowest price to cash flow ratio, which gives it plenty of leeway to increase returns to shareholders.

While the price to sales ratio isn’t the lowest amongst its peers, it’s still compelling at 1.69x.

When we look at profitability, LMT doesn’t have the best gross or net income margin. That honor belongs to Northrop Gruman.

You could easily make the case that NOC is a better play based on its margins. However, when we look at the growth metrics, NOC simply doesn’t stack up.

While Lockheed’s growth isn’t spectacular going forward, we feel it’s likely understated given management’s recent forecast.

And when you look at the 3-year growth rates for revenue and EBIT, it’s plain that Lockheed knows how to drive results over the long-haul.

Our Opinion – 7/10

Lockheed is a fantastic company with plenty of shareholder friendly buybacks and dividends.

Management consistently drives revenue growth and margin expansion.

Shares have gotten a bit pricey in the last couple of months. We’d like to see them down near $350 for a nice margin of safety for an investment.