Add it all up and you get an incredible magic formula stock. As a matter of fact, it’s got a ton of the characteristics we look for in GuruFocus’ own Micro-Cap Magic Formula Newsletter: non-cyclical industry, big barriers to entry, great returns on capital and strong cash flows.
Lockheed has some huge competitive advantages that allow it to earn outstanding returns on capital. The government contracts it serves require huge investments in R&D and global scale. New competitors don’t just pop up into the business. It’s the same group of four to six companies bidding for each contract. Aircraft, for instance, require hundreds of millions, even billions of dollars in R&D before even the first plane can be produced. It’s not exactly a business a startup is going to enter, and it’s unlikely that any huge companies are going to want to invest the massive amounts required to get into the business when it’s not even certain they’d be able to compete. Moreover, the contracts tend to be extremely sticky and many call for built-in levels of profitability, providing for strong visibility into future cash flows.
For example, Lockheed’s F-35 plane is the newest in a long line of fighter jets that have been produced by Lockheed. They’ve produced the line for so long and developed such deep relationships that it’s difficult to foresee them losing the contract.
So just how cheap is LMT?
Currently, it trades for just under 10x trailing earnings, 5.8x EV / EBITDA, and more than a 5% dividend yield.
Obviously, all those metrics are cheap. But what makes the company so interesting isn’t just their trailing twelve months valuation. It’s how cheap they are based on their proven earnings power over the past 5 to 10 years.
For example, Lockheed has earned more than $7 per share in each of the past four years. In other words, they’re trading under ten times average earnings for the past four years! That’s very cheap.
Another nice way of looking at it is Lockheed has averaged almost $2.5 billion in share repurchases per year over the past three years. Currently trading for a market cap of $25 billion, that means Lockheed could theoretically repurchase all of their shares over the next 10 years!
However you look at it, it adds up to Lockheed trading for a huge discount to what it’s historically earned.
Of course, no discussion of Lockheed would be complete without discussing the ongoing budget crisis. It’s clearly what the market is worried about, and the market is cutting in some pretty hefty cuts to the defense budget. But there’s reason for optimism. It’s proven very difficult in the past to make any meaningful cuts in the defense budget, and the last time it happened (in the mid ‘90s) there was actually a huge boom in the stock prices of defense industry players as the market priced in much too large a decline and the industry effectively worked through the budget decrease by merging and slashing costs.
So while the outlook may look bleak, take heart in knowing that the company has been here before and gotten through it successfully. The market’s pricing in a pretty bleak future and offering an outstanding company at a great price. That’s why it makes a great magic formula pick.