Best-in-Class Lockheed Martin Remains a Value Opportunity

The aerospace and defense company continues to deliver, but is undervalued by at least a low double-digit percentage

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Oct 23, 2020
Summary
  • The company posted better-than-expected results earlier this week and raised its guidance once again.
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I have long been a fan of Lockheed Martin Corp. (

LMT, Financial), the world's largest defense contractor, as the company is in a prime position to capitalize on increases in defense spending.

The company posted better-than-expected results earlier this week and raised its guidance once again. The stock experienced a bit of a selloff following the release of the earnings report, but shares continue to look inexpensive based on the company's historical valuation as well as its intrinsic value as calculated by GuruFocus.

Let's examine Lockheed Martin's most recent results more in detail.

Quarterly highlights

Lockheed Martin reported third-quarter earnings results on Oct. 20. The company's earnings per share of $6.25 were 16 cents ahead of Wall Streets' estimates and an increase of 10.4% from the previous year. Revenue grew 8.7% to $16.5 billion, $358 million more than expected.

Every segment within the company showed positive growth.

Aeronautics grew 8% to $6.7 billion. This segment continues to benefit from higher volumes for the F-35 program. Classified development contracts were up $130 million. Operating margins fell 20 basis points to 10.6%

Missiles and Fire Control was the real standout as sales were up 14% to just under $3 billion. Tactical and strike missile programs experienced an increase in demand. Integrated air and missile defense, led by the Patriot Advanced Capability-3 and Terminal High Altitude Area Defense programs, also saw higher volumes. Lower volumes for the Apache program led to a slight decline in sensors and global sustainment programs. Operating margins improved 20 basis points to 13.6%.

Revenue for Rotary and Mission Systems improved 8% to $4 billion. An increase in production volumes for the Sikorsky line of helicopters provided the majority of the growth this quarter. Also contributing to results were training and logistics solutions, integrated warfare systems and sensors. Volumes for combat ships were weaker. Operating margins were higher by 90 basis points to 10.1%.

Space increased 6% to $2.9 billion. This segment continues to see better sales for government satellites, but strategic and missile defense programs were also solid. Operating margins fell 280 basis points to 8.7% due to lower equity earnings from the company's investment in a space program.

Overall, operating margins decreased 90 basis points to 13%. This was below consensus estimates of 13.3%.

Lockheed Martin raised its guidance for 2020, something it has done every quarter so far this year. The company now expects earnings $24.45 per share for the year, above its prior forecast of a range of $23.75 to $24.05. Lockheed Martin expects sales of $65.25 billion for 2020, also above its prior guidance of $63.5 billion to $65 billion.

The company also gave guidance for next year. Lockheed Martin expects net sales of $67 billion, which would be an increase of just 2.7% from what is expected for 2020. The company is guiding toward operating margins of 10.9% to 11.1%.

The combination of lower operating margins for the third quarter and guidance for next year are the likely reasons that the stock was down almost 5% the day after the earnings report.

Lockheed Martin has often been more of an "under promise and over deliver" type over the past few years. As a reminder, the company has increased its guidance each quarter this year.

The company also boasts a massive backlog after winning a total of $17 billion in new orders. The backlog increased $6.5 billion, or 4.5%, to $150.4 billion. This is a new record and would take Lockheed Martin two and a half years to work off based on last year's sales of $60 billion.

Lockheed Martin might be guiding toward low single-digit sales growth next year, but given the company's history of several upward revisions annually and record backlog, I believe that the business will be just fine at the end of next year.

Valuation and potential returns

Using the current share price of around $373 and expected earnings per share for the year, Lockheed Martin has a forward price-earnings ratio of 15.3. This is below the stock's 10-year average multiple of 15.5 times earnings according to Value Line.

I continue to believe that the company's business results and higher defense spending in general warrant a higher price-earnings multiple. My valuation target range is 17 to 19 times earnings for Lockheed Martin.

Applying expected earnings per share for 2020 to this range results in a price target of $416 to $465, which is 11.5% to 25% above the current share price.

The GF Value Line appears to agree with me as it says that the stock is currently trading below its intrinsic value.

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Lockheed Martin's GF Value is $415.68, meaning that the stock currently has a price-to-GF Value ratio of 0.90. This places the stock very close to the low end of my price target range for the stock and earns Lockheed Martin a rating of modestly undervalued according to the chart.

Final thoughts

Lockheed Martin continues to demonstrate solid top and bottom-line growth. All four segments of the company had at least mid-single-digit growth in the most recent quarter. It was nice to see that Missiles and Fire Control performed better than the company's more well-known Aeronautics division, showing that Lockheed Martin has more than just its F-35 program to brag about.

Even with all of the positive going for it, the stock continues to trade below its long-term average valuation as well as its intrinsic value.

In addition, Lockheed Martin offers a dividend yield of 2.8%, which is more than a full percentage point above the average yield of the S&P 500. The company has increased its dividend by an average of more than 13% over the last decade.

Investors are getting a solid yield while waiting for the market to give Lockheed Martin's stock its proper due. I continue to find the stock attractive price, which is why I added to my position on Oct. 22 at a price of $368.60.

Investors looking for an entry point into Lockheed Martin could do very well buying the stock at the current price.

Disclosure: The author maintains a long position in Lockheed Martin.

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