Lockheed Martin (LMT, Financial) has long been my favorite name in the aerospace and defense sector. The company is the largest defense contractor on the planet and has regularly beaten and then raised its guidance over the past few yeras.
As the global leader in defense sales, Lockheed Martin benefits from higher government spending on defense. The company has also compounded its dividend by 13% over the last 10 years.
Lockheed Martin reported first-quarter results on April 21 that reaffirmed its status as the top company in the aerospace and defense sector, in my opinion.
Source: Lockheed Martin’s First Quarter Earnings Results Presentation, slide 3
Revenue grew 9.2% to $15.7 billion, which was $585 million higher than expected. Earnings per share increased 1.5% to $6.08, which was $0.24 above estimates.
Aeronautics had sales growth of more than 14%, with operating margins improving 10 basis points to 10.6%. Much of this growth was due to the F-35 fighter plane program. The company delivered its 500th unit during the quarter. With a backlog of more than 3,300 F-35s, which is the most expensive piece of military equipment in the U.S. budget, Aeronautics should continue to produce strong results going forward. This is important, as this segment contributes ~40% of annual sales.
Rotary & Mission Systems’ sales were essentially flat, but the operating margin declined 10 basis points to 10%. The Sikorsky helicopter program saw a slight decline during the quarter. This is likely not an issue for future quarters, as the program had $4 billion worth of bookings. RMS had $7 billion in total bookings, the most for any segment of the company.
Sales for Missiles & Fire Control improved 11.4%, though the operating margin decreased 260 basis points to 15.1%. Tactical and strike missile programs were in high demand during the quarter. The decline in operating margins was due to lower risk retirements on international contracts. This means that the actual costs were lower than the estimated total costs for these contracts.
Space grew 10.5% year-over-year, though the operating margin decreased 310 basis points to 9.6%. Higher sales of strategic and missile defense systems, especially in the areas of hypersonic and ballistic missiles, were the main contributors to growth in the quarter. Government satellite programs also had higher volumes. Again, operating margins decreased due to revisions on estimated costs.
The company bought back $756 million worth of stock during the quarter while distributing $693 million worth of dividends. This combined cash return represented just 72% of free cash flow during the quarter.
Lockheed Martin added $15 billion in bookings during the quarter, which kept its backlog at $144 billion.
Lockheed Martin also offered revised guidance for 2020.
Source: Lockheed Martin’s First Quarter Earnings Results Presentation, slide 8
The only change from guidance from January is a slight lowering of sales estimates. Hitting the midpoint of this update sales guidance would still result in a 5.5% improvement from results for 2019.
Nearly all of the decline in sales guidance is due to the Aeronautics segment. Social distancing orders around the world are likely to have an impact on the company’s F-35 program production numbers for the year. As the largest part of the company, this will have some impact on sales. Still, mid-single-digit sales growth is solid given the environment. EPS is still expected to grow by 8.4% at the midpoint, while segment operating profit targets remain the same.
Slightkly reduced production numbers for the F-35 aren’t a serious blow to Lockheed Martin’s business, as the other segments should perform as expected. Lockheed Martin’s guidance shows me that management believes that the company’s business should be relatively free from a significant impact from COVID-19 outside of the F-35 program.
Using the recent closing price of $380.40 and the midpoint for 2020 EPS, I give Lockheed Martin a forward price-earnings ratio of 16. This compares to the stock’s five and 10-year average valuations of 19.4 and 15.5, respectively.
Given Lockheed Martin’s leadership position in aerospace and defense, I feel that shares deserve a premium to the longer-term historical valuation. A price-earnings ratio in the range of 17 to 19 would be comfortable for me to invest in. Using the company’s guidance for the year, this could result in a share price range of $405 to $452. This would be a gain of 6.5% to 18.8% off of current levels.
Added to this return would of course be the stock’s yield of 2.5%, which is 40 basis points higher than the average yield of the S&P 500. Lockheed Martin has a well-covered dividend, with the annualized dividend of $9.60 consuming just 40% of expected EPS for the year.
The company’s guidance forecasts at least $7.6 billion of cash from operations this year. The company’s capital expenditures averaged $1.3 billion over the last three years. Being cautious, I estimate free cash flow to be at least $6 billion for 2020. Using the diluted share count of 282.6 million and annualized dividend, the company should distribute $2.7 billion in dividends in 2020. This results in a free cash flow payout ratio of 45%.
Lockheed Martin had a solid quarter with three out of four divisions showing double-digit growth rates. The company also has a massive backlog that would provide more than two years’ worth of sales using first quarter’s result. Sales for the year guidance was reduced slightly, mostly due to impact on the Aeronautics division, but this isn’t a company-wide issue.
In conclusion, Lockheed Martin’s first quarter did nothing to change my opinion that it is the best name to own in the aerospace and defense sector. Shares offer a solid potential return and a safe dividend. I continue to rate shares of Lockheed Martin as a buy.
Disclosure: The author is long Lockheed Martin.
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