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John Engle
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Lockheed Martin: A Lot Is Riding on the F-35 Fighter Program

The company's next-generation fighter jet continues to face delays, potentially threatening a key profit driver

January 20, 2021 | About:

Lockheed Martin Corp. (NYSE:LMT) has long been a premier Pentagon contractor, a status that has earned it a leading role in a number of critical military procurement programs. Foremost among these in recent years has been the development of the F-35 Lightning II Joint Strike Fighter. The next-generation fighter jet is slated to play a pivotal role in U.S. defense and force projection policy for many years to come.

Yet the F-35 development program has been marred by cost overruns and delays resulting from a myriad of technical issues. Recent delays to contract approvals has added another layer of uncertainty, which has in turn sparked mounting investor anxiety. Such concerns may be understandable since the F-35 is not only important to national security, but also critical to Lockheed's financial security.

Lockheed's essential program

The F-35 entered formal development in 2001 when Lockheed was selected by the Pentagon and North Atlantic Treaty Organization to spearhead their Joint Strike Fighter program, beating out a rival bid from Boeing Co. (BA).

Designed to serve as the new centerpiece of U.S. and NATO warfighting strategy, a lot is riding on the F-35's success. Official estimates have projected an annual cost of $12.5 billion for the F-35, with the full program life-cycle cost expected to hit $1.1 trillion. That makes the F-35 Lockheed's most lucrative, and most important, contract.

The F-35 may even end up bigger than expected, according to the company's research. In 2019, Lockheed predicted that demand for the F-35 could eventually mirror that of its popular predecessor, the F-16, which saw a production run of 4,600 aircraft. However, that may prove to be a somewhat overly optimistic view, given that it is approximately 40% above analysts' current average production estimates.

Whether F-35 demand ends up following the official forecast or Lockheed's more bullish estimate, it is still a massive contract that is set to define the trajectory of the company's financial performance for years to come.

Waiting on production approval

The development of the F-35 has proven to be anything but smooth. Cost overruns, missed deadlines and technological glitches have all conspired to dent the program. 2020 was marked by a number of additional delays thanks to the far-reaching disruptions wrought by the coronavirus pandemic. In September, Lockheed announced additional delays to scheduled F-35 deliveries, citing the pandemic's impact on the supply chain of a number of critical components that would not be fully resolved until late 2021.

While Lockheed's supply chain disruptions are concerning, they pale in comparison to the most serious delay facing the F-35. Once expected to enter rate-production in late 2019, the F-35 has yet to receive approval from the Pentagon. Indeed, the Department of Defense repeatedly punted on the decision multiple times last year. Last month, the Pentagon again delayed the rate-production contract decision, leaving it to the Biden administration to make the final call.

The rate-production contract, which is set to jumpstart the rollout of F-35 fighters, is crucial to the success of the program. With a price tag set at $398 billion, Lockheed can ill afford further delays or serious modifications to the contract.

Making progress despite uncertainty

Despite the delay to rate-production approval, Lockheed has still managed to post some solid wins in relation to the F-35. Indeed, as I recently discussed, Lockheed was awarded nearly $2.4 billion in December to advance elements of the F-35 program, including funds to procure a number of long-lead components needed to produce a Pentagon order of 133 jets. Lockheed also won State Department approval last month for the sale of 50 F-35 jets to the United Arab Emirates.

Thus far, Wall Street seems largely unperturbed by the delays. On Dec. 22, Credit Suisse reaffirmed its buy rating, upping it price target from $400 to $409. Goldman Sachs, having wavered slightly on its highly bullish call in September, has also come around, exuding confidence in the aerospace and defense company's prospects in a year-end update.

Lockheed Martin is scheduled to release its fourth-quarter earnings report on Jan. 26. The company's most recent guidance calls for full-year earnings of $24.45 per share, up slightly from the $23.75 to $24.25 it predicted earlier in the year, as well as slightly over the Wall Street consensus estimate of $24.13.

My verdict

While an earnings beat would certainly be welcome, I suspect many investors will be more interested in a much-needed update on the F-35. With Lockheed's financial future potentially hinging on the success of the program, my recommendation to investors is to pay close attention for any updates, comments or guidance related to the F-35.

Disclosure: No positions.

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About the author:

John Engle
John Engle is president of Almington Capital Merchant Bankers and chief investment officer of the Cannabis Capital Group. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin, a diploma in finance from the London School of Economics and an MBA from the University of Oxford.

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