Lockheed Martin Corp. (LMT) is up approximately 10% so far in 2021, which is an underperformance to the S&P 500 Index’s return of 13.1%.
Still, Lockheed Martin is a well-run company operating in an industry that is likely to continue to see higher spending regardless of which political party controls the White House and Congress.
The stock offers a solid dividend yield and lengthy track record of dividend growth.
Even better, Lockheed Martin is trading at a very reasonable valuation and is likely to offer mid-double-digit total returns going forward. Let’s look at why the stock is an excellent investment option for those seeking high total returns.
A look at earnings results
Lockheed Martin last reported quarterly earnings results on April 20. Revenue grew nearly 4% to $16.3 billion, though this was $80 million below what Wall Street analysts had predicted. Net earnings totaled $1.8 billion, or $6.56 per share, compared to $1.7 billion, or $6.08 per share, in the previous year. Earnings per share was an 8% improvement from the prior year and topped estimates by 25 cents. Included in this result is an 18-cent benefit from unrealized gains from investments held in the Lockheed Matin Ventures Fund. Excluding this, earnings per share was still higher by 5% compared to the first quarter of 2020.
Revenue for the Aeronautics segment of $6.39 billion were almost identical to the prior year’s total. Higher classified volumes were the main driver of growth, though the F-16 program did see an uptick in production contract volumes. Sustainment volumes were down a small amount. The F-35 program, which is the largest within the company, was lower due to a reduced product booking rate and slightly lower volumes. The operating margin expanded 30 basis points to 10.9% on account of higher risk retirements on sustainment contracts as well as from increased volumes on production contracts.
Missiles & Fire Control grew 5% to $2.75 billion. Integrated air and missile defense programs remain in high demand from customers, especially for the Patriot Advanced Capability-3 program. Tactical and strike missile programs enjoyed higher volumes for several programs, including the Joint Air-to-Surface Standoff Missile and the Long-Range Anti-Ship Missile. Sensors and global sustainment programs were weaker due to lower volumes in certain areas. The operating margin contracted 70 basis points to 14.4%. Gains in missile defense was more than offset by weakness in sensors and sustainment programs.
Rotary & Mission Systems had a 10% increase in revenue to $4.11 billion. This segment benefited from higher demand for training and logistics solutions programs, especially in international pilot training. Sikorsky helicopters had an increase in production volumes. Offsetting these gains were lower demand in surveillance and reconnaissance programs. The operating margin improved 50 basis points to 10.5% due to an increase in sales for integrated warfare systems and sensors programs.
Space revenue of $3 billion was a 3% increase from the same quarter a year ago. Key areas of growth included the Atomic Weapons Establishment and Commercial Civil Space programs as both businesses saw higher volumes. Space Transportation was especially robust. The operating margin did fall 210 basis points to 7.5%, caused by lower risk retirements in National Security Space and lower equity earnings from Lockheed Martin’s investment in United Launch Alliance.
The backlog was up slightly to $147.4 billion, with a mid-double-digit increase in Space more than offsetting a slight decrease in Aeronautics.
Lockheed Martin possesses one of the better-looking balance sheets in the industrial sector. At the end of the quarter, the company had total assets of $51.4 billion, current assets of $20.3 billion and cash and equivalents of $2.9 billion. This compares to total liabilities of $45.1 billion and current liabilities of $14.7 billion. Total debt stood at $12.1 billion, but just $506 million of debt matures within the next year.
Following first-quarter results, Lockheed Martin now expects earnings per share in a range of $26.40 to $26.70, up from $26 to $26.30 previously. This was above consensus estimates of $25.96. Revenue is now believed to be a in a range of $67.3 billion to $68.7 billion, up from $67.1 billion to $68.5 billion. Revenue projections did come up about $200 million short of what analysts had anticipated. At the midpoint, earnings per share would be an 8.3% increase and revenue would represent growth of 4% from the previous year.
Takeaways
Following quarterly results, Lockheed Martin has now increased year-over-year revenue totals every quarter except for three and beaten analysts’ expectations for earnings per share every quarter except for four dating back to the beginning of 2016. The company is very consistent and usually outperforms the market’s estimates.
Speaking of raising estimates, Lockheed Martin tends to provide conservative guidance for the following year on the fourth-quarter conference call. Leadership often raises its guidance several times per year. This trend continued in the most recent quarter.
The company has been able to beat estimates and show meaningful growth due to higher defense spending. Lockheed Martin’s leadership position as the largest defense contractor in the world puts the company in a prime position to capture a portion of these increases.
The Department of Defense released its fiscal year 2022 budget request at the end of May. The budget request was for $752.9 billion, including $715 billion for the department. The total amount is essentially flat compared to fiscal year 2021 budget request of $753.5 billion, but there is roughly $10 billion more for the department.
Included in the budget is a request for funding for 85 F-35s as well as missile and space programs, the majority of which are an increase from the prior year.
Lockheed Martin also benefits from a limited number of companies that can produce the arms that it does, making it a logical choice of governments for nearly every program that it offers. Once the contracts are signed, the customer is usually on the hook for any cost overruns as creating new products comes with risks. This allows for innovation on Lockheed Martin’s part while also reducing the likelihood that the government will not switch to a new contractor.
Government contracts also tend to be long dated, benefiting the contractor as it can take years to put a program into a position where it can be operational ready. For example, it took nearly 20 years for the F-35 to go from prototype to being declared operational ready. On top of this, sustaining the program for years after delivery instead of funding a new one keeps costs lower for the customer while also providing the contractor additional revenue.
All of this has put Lockheed Martin in a favorable business position and has allowed the company to produce plenty of cash from operations, with the first-quarter total reaching $1.7 billion. The company expects to generate more than $8.9 billion of cash from operations this year, up from its prior estimate of at least $8.3 billion. The company also believes it will produce at least $9 billion in cash from operations in each of the next two years.
Growth in all areas has allowed Lockheed Martin to raise its dividend for 19 consecutive years. The most recent increase raised the annualized dividend 8.3% to $10.40. This compares to the five- and 10-year compound annual growth rates of 7.7% and 11.7%. The projected payout ratio is just 39%, lower than the 10-year average payout ratio of 48%.
In addition to dividends, Lockheed Martin returns a large portion of capital to shareholders through buybacks. The company retired $1 billion worth of stock during the first quarter. The company has reduced its share count at an annual rate of 1.5% from 2011 through 2020. Between dividends and buybacks, Lockheed Martin remains one of the more shareholder-friendly companies in the industrial sector.
Valuation analysis
Lockheed Martin trades hands at around $390 per share. Using the midpoint of revised guidance of $26.55, the stock has a forward price-earnings ratio of 14.7. The stock’s five- and 10-year average price-earnings ratios are 15.5 and 18.1.
The last time I looked at the company, I felt that Lockheed Martin was undervalued. Following a more than $50 rally in the name., I still believe that the stock is cheap.
Using company estimates and a target price-earnings ratio of 15 to 18, which incorporates the medium- and long-term average valuations, I have a price target range of $398 to $479 for Lockheed Martin. This implies a possible share price appreciation of 2.1% to 22.8%. Factor in the current 2.7% dividend yield and the total return starts to stretch into the mid-20% area at the high end of my valuation target.
Final thoughts
Lockheed Martin’s first-quarter results were somewhat mixed, but still showed growth on both revenue and earnings per share. The company has an extremely large backlog that would last more than two years based on 2020 revenue totals.
The company is also in an advantageous position for its industry, has a sturdy business model and will continue to benefit from higher government spending on defense. The company has a solid yield, nearly two decades of dividend growth and a very low payout ratio.
While the stock lags the return of the market index for 2021, Lockheed Martin has the potential to see high double-digit returns from the current levels. As such, I remain very bullish on the future prospects for the company's shares.
