Lockheed Martin: Treasury Proxy (NYSE:LMT)


Ronald Martinez

The Impact of Government Contracts on Lockheed Martin

When it comes to government-owned companies, few fit the definition as closely as Lockheed Martin (NYSE:LMT). According to the company’s 2021 annual report:

In 2021, 71% of our $67 billion will be in Net sales were from the US government, either as a prime contractor or as a subcontractor (including 62% from the Department of Defense (DoD), 28% was from international customers (including foreign military sales (FMS) contracted by the US government) , and 1% came from commercial and other US customers.

Lockheed Martin often ranks first in terms of government contracts awarded to a single company (measured by absolute contract value in dollars), according to federal contract data from TenderAlpha. LMT is among the top suppliers to the Department of Defense, US Navy, US Air Force, etc. Therefore, it is important to keep track of incoming orders and contract updates to assess the company’s direction.

Lockheed Martin recently received USD 7.6 billion for Lot 15 of the F-35 program.

Before delving into the government spending data, it’s important to note that LMT reports its results with a fiscal year ending December 31, while the US government’s fiscal year runs from October 1 to September 30. For simplicity, we use monthly data below to illustrate the importance of government contracts.

Looking at the trend in government contracts awarded to Lockheed Martin (on a monthly basis) over the past few years, we see a strong correlation between government contracts awarded and stock performance.

For example, the roughly $20 billion awarded in November 2019 saw the stock gain roughly 3.7% in value, in line with the 3.7% increase in the Dow Jones Industrial Average. In March 2020, another strong month for contract awards, LMT lost 8.4% while DJI lost 13.7%.

Committed LMT dollar amount per month

Committed LMT dollar amount per month (www.tenderalpha.com)

Comparing the performance of Lockheed with the S&P Aerospace and Defense sector ETF, trading under the ticker ITA, we see that LMT underperformed in November 2019 but outperformed in March 2020:

Stock/Index/ETF Nov 2019 March 2020
LMT 3.7% -8.4%
DJI 3.7% -13.7%
IT 5.1% -28.3%

Source: Author’s calculations

Overall, it is fair to say that government contracts have a significant impact on LMT shares. Additionally, Lockheed is perceived by the market as a less risky defensive position and the company is viewed as a safe haven in turbulent times thanks to its stable government business.

Overview of Lockheed Martin 2022 Q2 results

Lockheed Martin reports results in four key segments, namely Aeronautics with 38% of Q2 2022 net sales, Missiles and Fire Control with 18% of Q2 2022 net sales, Rotary and Mission Systems with 26% of Q2 2022 net sales and Space travel with 18%. of net sales in the second quarter of 2022:

Distribution of sales between the segments

Distribution of sales between the segments (Lockheed Martin Form 10-Q Q2 2022)

Lockheed reported a 9.3% year-over-year drop in sales, citing supply chain issues and the timing of a key F-35 contract as key drivers of the sales decline. On the other hand, operating margins were better, improving to 11% from 10.4% in the year-ago quarter. Overall, operating income fell 3.7% Y/Y.

Earnings per share were heavily impacted by a pension risk transfer fee of $4.33 and were $1.16 on a GAAP basis, or $6.32 on an adjusted basis:

EPS Bridge between GAAP and Adjusted EPS

EPS Bridge between GAAP and Adjusted EPS (Presentation of Lockheed Martin Q2 2022 results)

Considering the weighted average diluted shares outstanding of $266.7 million, we see that the pension risk transfer expense was approximately $1.15 billion, which is less than the positive other comprehensive income of positive recorded in the quarter $2.8 billion:

Lockheed Martin bridge to overall result

Total Comprehensive Income Bridge (Lockheed Martin Form 10-Q for Q2 2022)

All in all we can say that pensions were a net gain for LMT for the quarter.

Highlights of the call include a more detailed F-35 production plan through 2025, saying production will be slightly below the long-term goal of 156. In light of the war in Ukraine, requests for the purchase of military equipment have increased across the board, but it remains to be seen what percentage of these interest intentions will translate into actual orders:

The reality today is none of this is under contract. And so we’re trying to get a better understanding of the timing of which ones are contracted and then get a better understanding of our supply chain capability to determine when we can actually deliver. But I can say with a degree of reasonable confidence that our prospects for orders and backlog over the next two years are better than they were a year ago. However, it will be some time before this translates into revenue beyond that timeframe. – Source: CFO Jay Malave on Q2 2022 conference call

Management also reiterated its intention to return 100% of free cash flow to investors via dividends and buybacks, and to position the company with a lower share count for the period of expected revenue growth in the coming years.

Backlog increased marginally to $134.6 billion (Q1 $134.2 billion), with 59% expected to be realized over the next 24 months.

On the outlook, LMT cut its 2022 revenue guidance by 1% to $65.25 billion, while keeping its free cash flow guidance of over $6 billion intact thanks to stronger operating profit margins.

Lockheed Martin as Treasury Bond Agent

For investors, how they approach Lockheed Martin seems like the right way to value the company from a pure cash flow perspective. Looking at the balance sheet, we see that as of June 26, 2022, LMT had equity of $11.43 billion, which included $10.8 billion in goodwill and $2.6 billion in net intangible assets:

Lockheed Martin balance sheet

Lockheed Martin balance sheet (Lockheed Martin Form 10-Q for Q2 2022)

If you discount the goodwill and other intangible assets, Lockheed Martin has essentially no tangible equity after you factor in the liabilities. As such, the current valuation of approximately $115 billion is based solely on the company’s revenue generating capacity and not some tangible assets. Therefore, any forward-looking government debt data that TenderAlpha is able to offer could prove to be a strong indicator of the Company’s future performance.

Lockheed’s current payout for dividends of its $6 billion projected free cash flow is about 50%. While the dividend yield of around 2.6% is unimpressive in itself, the medium-term growth prospects are solid.

We can assume that LMT will experience a short phase of above-average growth due to the current geopolitical situation. Expect tensions to ease and growth to be in line with GDP. One risk in this de-escalation scenario is that there will actually be a fall in the demand for armaments, ie the jump in sales that is currently expected could be followed by a slump in sales across the board.

If free cash flow grows 10% annually over the next three years, it could well reach the $8 billion discussed by analysts during the earnings call. In this scenario, the free cash flow yield would be around 7% versus the current market cap in 2025, which coupled with an overall economic growth rate of 3% (which is also commonly thought to be the military spending growth rate) should take the post-2025 expected return to around 10%.

With free cash flow growth and buybacks looming, it’s not inconceivable that the 2025 dividend yield will be around 3.5% versus the current share price.

An alternative way to take a position in Lockheed would be to consider the company’s 3.8% 2045 bonds, which currently trade at about 88% of face value. The current yield is 4.3% and you get nice capital protection by buying below par. The bonds were trading in the 115-120% of par range just last year, and if yields fall, the 2045 issuance offers excellent capital growth potential, arguably with very limited downside given the common stock’s strong recent performance:

Development of the bond price 2045

Berlin Stock Exchange


Keeping an eye on contracting is key to assessing Lockheed Martin’s near- and long-term prospects, as the company relies on government spending for 99% of its revenue. With defense spending set to increase in the coming years due to the war in Ukraine and rising geopolitical tensions, LMT is well positioned to remain resilient through turbulent times.

The company’s prospects have improved significantly, and investors have taken notice, sending its share price up about 18% year-to-date.

This has greatly frontloaded yields and created a situation where long-dated bonds could be a more attractive way to get into the company. It can be argued that its current price does not reflect LMT’s improved business prospects, making it an attractive investment for anyone looking to invest in the company.

However, should events play out broadly as expected, free cash flow should improve significantly over the coming years and LMT would be able to deliver significant dividend growth in excess of what US Treasuries offer.

Lockheed Martin is a solid example of a company whose performance is positively impacted by government procurement.


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