Shares of Lockheed Martin have had a suboptimal performance over the past few months. Shares have fallen almost 11% since the last time I looked at the company right after third-quarter earnings results.
Even the near term has been a bit of a letdown. The stock is down almost 2% since the company reported fourth-quarter earnings results last week, while the iShares U.S. Aerospace & Defense ETF (ITA, Financial) is higher by 3.3%.
This performance followed two quarters that showed impressive top and bottom-line growth. The market has shrugged at Lockheed Martin's strong performance, likely in light of guidance for 2021.
The market may not always leave the stock this undervalued. In this article, I will go over why I believe the current weakness in Lockheed Martin shares should be seen as a buying opportunity.
Earnings highlights
Lockheed Martin reported fourth-quarter and full year earnings results on Jan. 26. For the quarter, revenue grew 7.3% year-over-year to $17 billion, which was $108 million more than Wall Street analysts had expected.
Net earnings from continuing operations totaled $1.8 billion, or $6.38 per share, compared to $1.5 billion, or $5.29 per share, in the year-ago period. Lockheed Martin's net earnings grew 20% while earnings per share were almost 21% higher than the prior year, but it missed analysts estimates by 3 cents. A lower share count accounts for the difference in net earnings and EPS growth rates. Operating profit margins expanded ~70 basis points to 11%.
For full-year 2020, revenue improved 9.4% to $65.4 billion, which was above the company's guidance of $65.25 billion provided following the third-quarter earnings release. The guidance at the time of the previous quarter was itself an increase as well, showing that Lockheed Martin often produces results that are better than leadership had previously said it would.
Net earnings from continuing operations totaled $6.9 billion, or $24.50 per share, compared to $6.2 billion, or $21.95 per share in 2019. As with revenue, EPS for the year came in above the high end of company guidance of $24.05. For the year, net earnings grew 11.3% and EPS improved 11.6%. Again, a lower share count explains the difference in growth rates. The operating margin of 10.9% was essentially flat from the prior year.
I've noted in previous articles that Lockheed Martin's management does tend to start the year with lowered expectations that seem to be raised every quarter. Perhaps this explains some of the tepidness from investors over the past few months.
Still, Lockheed Martin had a strong quarter and 2020. The quarter saw high single-digit revenue growth and a 20%+ gain in both net earnings and EPS. Full year results topped the company's guidance for both revenue and EPS. Each segment of the company produced growth in the most recent quarter.
Aeronautics, the largest business within Lockheed Martin, had revenue growth of 5.2% to $6.7 billion in the fourth-quarter. This segment benefited from higher volumes for international sustainment and production contracts for the F-16 fighter program. The F-35 fighter program, which is the company's largest source of revenue, was only a slight addition to results as volumes for sustainment contracts were offset by lower production volumes. Operating margins expanded 20 basis points to 10.8%.
There are some unknowns related to the F-35. Late last year, the Department of Defense placed a hold on full-rate production of the F-35 due to testing issues. This would be the most lucrative phase of production for Lockheed Martin, so a delay on the production could have a short-term impact. Lockheed Martin has a backlog of a potential 2,600 aircraft. Assuming successful testing, the company is well positioned for F-35 production.
Missiles & Fire Control was higher by 3.5% to $2.9 billion. Integrated air and missile defense programs remain in high demand, especially the company's Terminal High Altitude Area Defense and Patriot Advanced Capability-3 programs. Operating margins improved 40 basis points to 13%.
Rotary & Mission Systems grew 8.3% to $4.2 billion, which benefited from higher sales for the Sikorsky helicopter program. Higher volumes for Combat Rescue Helicopters and the Seahawk were among the programs singled out as strong performers. Integrated warfare systems and sensors also had higher volumes. Training and logistics solutions, which had seen robust growth in the prior quarter, were slightly weaker this time. The operating margin was up 50 basis points to 9.6%.
Space, which was the weakest component of the company as recently as a few years ago, was up 14.1% to $3.2 billion. Revenue growth was attributed to higher volumes for government satellites programs, something that has been a trend for several quarters now. This segment also had higher demand for strategic and missile defense programs, especially in the areas of hypersonics. Operating margins improved 220 basis points to 11.4%.
Lockheed Martin ended the year with a backlog of 147.1 billion, or more than two years of work based on full year revenue results. This is slightly below last quarter's record backlog of $150.4 billion, but 2.2% higher than the previous year. Only the Space segment saw a decline in its backlog.
Lockheed Martin's balance sheet remains in solid shape. The company ended the year with total assets of $50.7 billion, current assets of $19.4 billion and cash and equivalents of $3.2 billion. Total debt stood at $12.2 billion, but just $500K of debt is due within the next year. The company generated a company record cash from operations of $8.2 billion in 2020, with free cash flow of $6.4 billion. Free cash flow easily covered $2.76 billion of dividend disributions and $1.1 billion of share repurchases during the year.
Guidance
The company also provided initial guidance for 2021. Revenue is expected to be in a range of $67.1 billion to $68.5 billion, which would be 3.7% growth at the midpoint from last year, but just below consensus estimates. EPS is expected to be between $26.00 to $26.30 for the year, which would represent 6.7% growth at the midpoint and be a penny better than expected by analysts.
Guidance for both revenue and EPS is weaker than growth rates seen in 2020, but investors should remember that Lockheed Martin's initial guidance is often raised several times during the course of the year, perhaps even as an intentional strategy by management (the company raised both top and bottom-line estimates twice last year and three times in 2019).
I believe that investors shouldn't let initial guidance keep them out of the stock as Lockheed Martin has a lot going for it. In particular, the stock's valuation remains very low and shares look attractively valued on a number of different measurements.
Valuation
Shares of Lockheed Martin closed Thursday's trading session at $337.23. Using the company's guidance for the year, the stock has a forward price-earnings ratio of 12.9. The stock has five-year and 10-year average price-earnings ratios of 18.5 and 15, respectively. Compared to its medium and long-term valuations, Lockheed Martin appears undervalued.
GuruFocus appears to agree with this assessment, as the stock is trading below its GuruFocus value:
Lockheed Martin has a GF Value of $418.19, which results in a price-to-GF Value ratio of 0.81 using the most recent price. Investors would see a 24% return if the stock were to trade with its GF Value.
Added to this would be the dividend yield, which is 3.1% today. For comparison purposes, the five-year average yield is 2.7%, which would also mean that the stock is undervalued based on its historical yield.
Looking at the stock's historical average valuation, intrinsic value or current yield versus its five-year average shows that Lockheed Martin could offer significant upside from current levels.
Final thoughts
Lockheed Martin followed up a excellent quarter and full year by offering up guidance that the market found to be on the weaker side. Shares remain cheap, trading at less than 13 times forward earnings. This is well below its historical valuation and well off of the stock's GF Value.
I added to my position in Lockheed Martin on Feb. 1 at a purchase price of $325.13 following the earnings release as I find the business mode and the company's leadership attractive. The stock also appears to be undervalued and has a dividend growth streak of 18 years.
Author disclosure: the author maintains a long position in Lockheed Martin.
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