Lockheed Martin: Crisis Winner (NYSE:LMT)

Article Thesis

Lockheed Martin (NYSE:LMT) is a leading aerospace and defense company. The current conflict between Russia and Ukraine provides tailwinds for the company, as many countries are increasing their defense spending in order to upgrade their military. At the same time, brewing tensions between China and the US could also result in some macro tailwinds for the company.

Lockheed Martin is a great dividend growth company, and it offers a reasonable dividend yield at current prices. At the same time, however, it should be noted that its valuation is far from low today. Waiting for a better buying opportunity could pay off.

Lockheed Martin As A Crisis Winner

The ongoing war in Ukraine is a major humanitarian crisis that also impacts many businesses negatively, e.g. due to disrupted supply chains. For the defense industry, the ongoing war provides growth tailwinds, however. It has become apparent that a major land war between two large countries is possible, even though many analysts and politicians had deemed it unlikely prior to February 2022.

Militaries in many countries had shrunken over the last couple of years, and political and military leadership had put the focus on capabilities such as anti-terrorism. Over the last couple of months, many news items have appeared that suggest that many NATO members in Europe are not prepared for a major land war. Three examples of that: The Times has reported that British ammunition depots are so depleted that reserves would be large enough for just one week of war. Newsweek reports that a NATO ex-General has stated that NATO isn’t prepared for a possible war with Russia. Politico has reported that Germany is running out of ammunition as well, despite a $100 billion defense spending program that was announced earlier this year.

With major NATO members being unable to fulfill their NATO duties, it is pretty clear that they will have to increase their military capacities dramatically going forward. Ammunition depots have to be refilled, military equipment has to be upgraded, and new fighter jets, tanks, anti-aircraft, and missile defense systems have to be acquired. Europe will thus likely see a hefty increase in military spending over the next couple of years, and some of that money will be flowing toward the pockets of Lockheed Martin and other US-based defense companies. In December, Germany announced a $10 billion deal for new F-35 jets that are manufactured by Lockheed Martin, as reported here on Seeking Alpha.

I do believe that there is a high chance that many additional deals for jets, weapon systems, ammunition, and so on will be signed over the next couple of years, with purchases from a wide range of NATO countries that need to build up their capabilities. Even the US, which has a very strong military, will continue to invest heavily in new systems, equipment, and ammunition — the Ukraine war is depleting stockpiles in the United States as well, as reported here on WSJ.

Ukraine is the geopolitical hotspot that is most in focus today, and rightfully so, but there are other tension points on top of it. Tensions between the US/Taiwan and China are elevated, and both sides will continue to invest in their militaries to increase capabilities. Likewise, many Middle Eastern countries are investing in their militaries in order to deter Iran. Israel, for example, is acquiring Lockheed Martin’s F-35 jet as well, while other countries in the area, including Saudi Arabia, Qatar, and the UAE, are interested in the F-35 as well.

Procurement of new equipment takes time due to lengthy processes when it comes to approvals and also production, but the current conflict in Ukraine is poised to have a beneficial impact on Lockheed Martin’s longer-term business growth. Investors shouldn’t expect a dramatic increase in revenue and earnings growth, however. Instead, this will be a notable, but not a game-changing tailwind, I believe.

The tailwinds from growing tensions around the world are visible in Lockheed Martin’s backlog, which has been growing in recent quarters. At the end of the most recent quarter, LMT’s backlog totaled $140 billion, which was up $5 billion year to date, despite higher revenues being generated (which shrinks the backlog, all else equal). With the current backlog, Lockheed Martin could generate revenues at the current pace for more than two years in a row without needing any additional orders, which makes the company pretty resilient. Even if there is an economic downturn next year, it would most likely not impact Lockheed Martin meaningfully, as the company has essentially locked in a large portion of its future revenue for many quarters.

Recent Results And Shareholder Returns

Lockheed Martin reported its most recent quarterly results in October. While the company missed revenue estimates slightly, Lockheed Martin was able to beat earnings per share estimates easily, as margins were a lot higher than expected. The company saw its net profit remain relatively stable year over year, as revenue increases were mostly offset by higher expenses, which isn’t surprising in an environment where raw materials, labor, transportation costs, and so on are climbing.

But thanks to the impact of share repurchases, earnings per share were nevertheless up meaningfully compared to one year earlier, rising from $6.60 to $6.87, which pencils out to a 4% increase.

During the third quarter alone, Lockheed Martin has spent $1.4 billion on share repurchases, which makes for an annual run rate of close to $6 billion. Since the company is currently valued at $127 billion, Lockheed Martin could buy back almost 5% of its shares per year at the current rate. That alone would allow for a mid-single digit annual earnings per share growth rate, even if net income were to never grow again. Buybacks can thus be a major value creator over time, as earnings per share growth is positively impacted by a declining share count. This fall, the company announced a $14 billion share repurchase program, which covers around 11% of Lockheed Martin’s market capitalization at current prices.

About $8 billion of that will be utilized in 2022, which includes a $4 billion accelerated share repurchase program. That will not be fully covered by free cash flows, which are forecasted at a little over $6 billion in 2022. Lockheed Martin will thus add some debt this year, but with the buyback pace likely slowing to some extent in 2023 and beyond, I assume that Lockheed Martin will keep its buyback spending more in line with its cash generation in order to prevent debt levels from growing too much in a rising rates environment.

Lockheed Martin has also raised its dividend in the fall of 2022, with a 7% boost that lifted the payout to $12 per year. That gives Lockheed Martin a great 20 year dividend growth track record. Since LMT’s dividend yield stands at 2.5% now, which is considerably higher than the broad market’s yield, and since the payout ratio is very undemanding, at 44%, Lockheed Martin looks like a good pick for a dividend growth portfolio, at least before we factor in valuation, which gets us to the next subject.

LMT: Currently A Bit Expensive

The good business growth prospects and the fact that LMT could benefit from the ongoing war in Ukraine have resulted in major share price gains for Lockheed Martin in 2022. Shares are up 38% so far this year, while the broad market has declined. This is great news for those that held LMT a year ago, but it does not mean that Lockheed Martin is a great buy at current prices.

Lockheed Martin currently trades at a 5% premium to its historical median earnings multiple. When we look at the company’s enterprise value to EBITDA ratio, which accounts for changes in debt usage, the company currently is ~15% overvalued. In total, Lockheed Martin looks like it is trading at a slightly expensive level today, relative to how the company used to be valued in the past. This makes me believe that buying LMT here, following a steep run, is not a great idea from a timing perspective, although Lockheed Martin looks strong fundamentally.

Takeaway

Lockheed Martin should, like other aerospace/defense companies, benefit from uncertainty and conflict around the world, as that should result in rising defense spending. Lockheed Martin is a quality company with shareholder-friendly management, but shares look too expensive for a buy rating at current prices. It’s best to buy shares when they are historically cheap, which is not the case here — LMT is trading at a premium relative to the normal valuation following the steep run in 2022.