Lockheed Martin (LMT)

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See all Bulls Reasons Bulls: Reasons To Buy Largest defense contractor has capacity for lucrative gov't contracts 100% agree Largest defense contractor has capacity for lucrative gov't contracts Lockheed Martin is the world's largest defense contractor with enough capacity for the most lucrative government contracts. Lockheed Martin is the leading aerospace company in the US and has had good earnings growth, but its PE ratio is lower than average for its... read more View or Edit Reason 6 votes 100% agree Increases in global instability will continue to fuel defense spending 100% agree Increases in global instability will continue to fuel defense spending Recent increases in global instability will continue to fuel defense spending and thus, Lockheed Martin's growth. View or Edit Reason 1 votes 100% agree Significant export opportunities for defense products 100% agree Significant export opportunities for defense products Current export opportunities for products such as the F-16 fighter jet and anticipated export opportunities for the Joint Strike Fighter will provide significant revenue. View or Edit Reason 1 votes 100% agree See all Bears Reasons Bears: Reasons To Sell High pension costs loom on horizon 100% agree High pension costs loom on horizon With the majority of its workforce set to retire, profits may be hurt by potentially high pension costs. View or Edit Reason 1 votes 100% agree Proportion of sales to the U.S. Government has increased 0% agree Proportion of sales to the U.S. Government has increased Proportion of sales to the U.S. Government has increased from 78% (2003) to 85% (2005), decreasing customer diversification. View or Edit Reason 0 votes 0% agree Pressure for fiscal responsibility could affect government contracts 0% agree Pressure for fiscal responsibility could affect government contracts Pressure for fiscal responsibility could result in the delay, reduction, or cancellation of certain government contracts. View or Edit Reason 0 votes 0% agree Send the authors a comment or suggestion Be the first to make a suggestion See All Suggestions

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United States government spending represents 85% of Lockheed Martin's revenue. As a result, the company is is extremely sensitive to political changes that impact federal government spending priorities. Historically, Republican political victories have benefited Lockheed Martin through increases in defense spending. Government defense spending once represented a reliable stream of income for Lockheed Martin and other defense contractors. Further, the government historically distributed contracts among major defense contractors to keep all of them afloat. In the 1980s, government contracts for defense projects became more scarce. Despite the recent surge in defense spending that has accompanied military activity in Iraq, the aerospace industry has not recovered fully from its 1980s contraction.

As is common in the defense industry, Lockheed Martin's operating costs are extremely high. In addition, Lockheed Martin faces enormous pension obligations. Three quarters of its 130,000 workers are scheduled to retire in the next 10 years, making its profits sensitive to changes in the interest rate. This was further illustrated in the first quarter 2008 earnings report. Lockheed reported a non-operating loss of $7 million versus a gain of $37 million in 1Q07 and specifically cited the interest rate's effect on the pension plan as the culprit.^[1]

[edit] History and Structure

Headquartered in Bethesda, Maryland, USA, Lockheed Martin was formed in 1995 by the merger of Lockheed Corporation with Martin Marietta Corporation. The company has been in charge of a wide variety of projects over time, including the production of the Hubble Space Telescope, managing several national laboratories (such as Oak Ridge and Sandia), developing missile systems, and aircraft.

2007

2007

As the defense budget grows to record levels, Lockheed Martin grows along with it. Lockheed Martin has been developing several new aircraft intended to replace retiring models, among them the Joint Strike Fighter (intended to replace the F-16 fighter jet), a contract which is valued at $200 billion not including additional sales to American allies.

Lockheed Martin uses its expertise in both vertical and horizontal integration to expand its product line, thus allowing it to become a competitor in a wider range of government contracts.

Lockheed Martin's product portfolio concentrates in electronic systems and aerospace, which account for 56% of its revenue. A complete list of products and services may be found here. Lockheed Martin caters to the defense and information needs of a variety of countries and organizations. While Lockheed Martin is traditionally known for providing cutting edge airplanes and electronic systems for the United States Government, it also provides lesser-known services such as implementing biometric controls for border security, and automated package processing for the U.S. Postal Service.

Lockheed's revenue grew modestly in 2007, with net sales increasing 6% to $41.9 billion. Net earnings, however, catapulted to $3.0 billion, a 20% jump from 2006. Volume increases in the F-22 program more than offset declines on the F-16 program. Lockheed's Information Systems & Global Services division achieved the highest sales growth (14%) in 2007, spearheaded by higher volume and growth in mission services activities and a series of acquisitions. No doubt, the ensuing War in Iraq and War on Terror guarantee solid growth for the firm. A combination of the needs expressed by the U.S. military and ability of Lockheed to meet those needs determines the firm's ultimate financial performance.

[edit] Customers

[edit] United States Government

The United States Government accounts for approximately 85% of Lockheed Martin's revenue. In terms of defense divisions, its major customers are the Air Force (25%), the Navy (22%) and the Army (9%). Current projects with the United States Government include the Joint Strike Fighter (JSF) program, which is now valued at approximately $275 billion and growing. The JSF contract will continue to generate revenue even after the completion of the plane through service agreements. The 2008 U.S. Federal budget is expected to show an increase in spending related to aircraft and space programs, which combined account for 46% of Lockheed Martin's revenue. Furthermore, Congress has been expressing desire to increase the United State's Navy, thus adding the potential for additional ships and at least 100 additional aircraft orders. However, there are several programs that are in danger. Cost overruns with Project Deepwater (Coast Guard) and the Litoral Combat Ship (Navy) could cause the programs to be delayed or even canceled.

[edit] Civilian and Non-Federal Organizations

Civilian organizations (domestic commercial) and state programs make up the smallest percentage of Lockheed Martin's revenue at just 2%. Lockheed Martin specializes in data processing, and has also begun expanding into human services projects, such as training people under state-run welfare-to-work programs.

[edit] Foreign Governments

The international arms market accounts for 13% of Lockheed Martin's revenue. Although the F-16 is no longer sold to the United States, international sales continue to be strong. Furthermore, the Joint Strike Fighter program is a multinational program, involving the United States, United Kingdom, Italy, The Netherlands, Canada, Norway, Denmark, Australia and Turkey, with the United States bearing the majority of the costs. Trade with foreign governments is vulnerable by trade barriers since the export of defense products is regulated heavily by the State Department.

[edit] Growth

Growth from 1998 to 2007

As the graph shows, Lockheed Martin has been greatly helped by the increased Defense spending after the September 11 terrorist attacks. Its growth continues to be fueled by global political instability, such as conflicts in the Middle East, particularly since Israel is Lockheed Martin's primary export partner.

While civilian contracts do not play a very significant role, Lockheed Martin's diversification program (even within government contracts themselves) may help them sustain their net income and revenue levels even during a time of global peace.

[edit] Costs

As the graph shows, Lockheed Martin has extremely high costs. However, it is important to note that its net income is very high when compared to other major defense contractors. High program costs as well as bidding wars between contractors for government contracts keep net income relatively low. Furthermore, all of its sectors in general have low operating margins. While high costs do impede growth, operating profits across all sectors have increased in the past five years.

[edit] Risks

[edit] Government spending

Lockheed Martin is very susceptible to fluctuations in the Department of Defense's budget since contracts with the United States Government account for 85% of its income. The distribution of government spending may also affect Lockheed Martin. For example the cancellation of future combat aircraft programs would detract from revenue. Lockheed Martin's revenue may also suffer given reduced defense or R&D spending, cutbacks on existing orders, or the Iraq War ending sooner than expected. The government sometimes cancels contracts if the cost of a program becomes larger than anticipated.

[edit] Foreign Markets

Arms sales to foreign governments is heavily regulated by the Arms Export Control Act. Foreign investments on behalf of Lockheed Martin, such as a joint venture with the Russian government on space systems, carries more risks due to instability in Russia.

[edit] US Politics

With the Democratic Party taking the majority of both chambers in Congress, there has been some speculation as to what will happen to the defense industry, especially because Democrats have recently been strong advocates for a balanced government budget. Defense aerospace spending and its growth rate have already been capped for the fiscal years 2008-2012. That said, it is very likely that Congress will still approve the purchase of additional aircraft and ships according to press releases by the Democrat-controlled House Appropriations Committee.

[edit] Pensions

Approximately 100,000 of Lockheed Martin's 130,000 person workforce are scheduled to retire within the next decade. Therefore, pension costs (especially when interest rates are low) can severely impact the company's profits. Since a large portion of Lockheed Martin's pension funds are in investment accounts, low interest rates can reduce the company's profits.

[edit] Comparison to Competitors

Lockheed Martin and competitors in the defense and aerospace industry are blessed by unusually high barriers of entry, thus limiting the number of major defense contractors eligible to obtain large and lucrative defense contracts. While recent changes in the government budget have targeted the IT sector and integrated systems projects, Lockheed Martin remains a strong competitor in the defense industry due to the makeup of both its customer composition and divisional revenue.

Lockheed Martin has a bigger net income than its competitors despite similar revenue. Only two of its competitors, Northrop Grumman and Boeing have the capacity for large systems, therefore enabling them to obtain the most lucrative of government contracts. On the other hand, Raytheon and General Dynamics focus on components of systems rather than systems as a whole.

[edit] References

1. ↑ Lockheed 1Q08 Earnings Release
2. ↑ Lockheed 1Q08 Earnings Release