By Callum Turcan
Image Shown: Lockheed Martin Corporation’s financial performance has held up well in the face of the ongoing pandemic. Image Source: Lockheed Martin Corporation – Second Quarter of Fiscal 2020 IR Earnings Presentation
Our favorite defense contractor is Lockheed Martin Corporation (LMT) as we like its focus on fiscal discipline, its stable cash flows, its operational prowess, its nice dividend, and its promising growth outlook. Additionally, shares of LMT yield ~2.5% as of this writing and Lockheed Martin’s per share quarterly payout has grown by roughly four-fold since 2009. The firm’s biggest growth driver for the foreseeable future is its F-35 jet fighter, though please note Lockheed Martin also has a major helicopter business after completing its purchase of Sikorsky Aircraft in November 2015. In this article, we will cover why we like Lockheed Martin and how we arrived at our fair value estimate of $432 per share of LMT.
Historical Financial Analysis
During the initial phases of the coronavirus (‘COVID-19’) pandemic, Lockheed Martin was able to continue churning out meaningful free cash flows, defined as net operating cash flow less capital expenditures. Over the first half of fiscal 2020 (period ended June 28, 2020), Lockheed Martin generated $3.9 billion in free cash flow, up 38% year-over-year. Lockheed Martin paid $1.4 billion covering its dividend obligations and another $1.0 billion repurchasing its stock during this period. Its net debt load shrank from $11.1 billion (inclusive of short-term debt) at the end of fiscal 2019 (period ended December 31, 2019) down to $9.8 billion (inclusive of short-term debt) as of June 28, 2020.
This strong performance is not an outlier, but part of a longer-term trend in the company’s financial and operational performance. Lockheed Martin has posted solid revenue growth on a GAAP basis over the past few fiscal years as you can see in the upcoming graphic below.
Image Shown: Lockheed Martin has steadily grown its annual GAAP revenues each fiscal year from fiscal 2017 to fiscal 2019. Image Source: Data from Lockheed Martin’s Fiscal 2019 Annual Report, chart made by Valuentum
As Lockheed Martin’s top line continues to grow on the back of rising F-35 deliveries, which grew from 66 deliveries in fiscal 2017 (period ended December 31, 2017) to 134 deliveries in fiscal 2019 (period ended December 31, 2019), management did a solid job controlling costs. Revenue growth combined with cost containment efforts and growing economies of scale helped drive Lockheed Martin’s GAAP operating margin higher during this period as you can see in the upcoming graphic down below.
Image Shown: Lockheed Martin’s GAAP operating margin has steadily climbed higher over the past few fiscal years. Image Source: Data from Lockheed Martin’s Fiscal 2019 Annual Report, chart made by Valuentum
As it concerns equity valuation, we are big believers that the true value of equities is entirely based on expectations of the company in question’s future free cash flows, discounted at the appropriate rate (the weighted-average cost of capital). The purpose of analyzing a company’s historical financial performance is to get an idea of how the firm might perform in the future. Backward-looking ambiguous metrics like trailing twelve-month P/E ratios do not provide any insight into a company’s true valuation or intrinsic value. Even forward P/E ratios fall short, as that only captures the firm’s expected performance over a one-year period, though most of the intrinsic value of equities comes from the mid-cycle (Year 6-Year 20) and perpetuity (Year 21+) business phases which we will cover in just a moment.
Based on our discounted free cash flow analysis, Lockheed Martin has a fair value estimate of $432 per share. In the upcoming graphic down below, we highlight the key valuation assumptions used in our enterprise cash flow models to derive that figure. Please note that our net debt figure takes the funded status of Lockheed Martin’s pension plan into account, and furthermore, that most of the intrinsic value of LMT comes from Year 6+ (with the forecasted discounted free cash flows from Year 1-Year 5 representing roughly one-quarter of the total intrinsic value of its equity). To read more about enterprise cash flow models and discounted free cash flow analysis, please check out our book Value Trap (we recently published a second edition that includes our commentary regarding COVID-19 and equity markets, among other things).
Image Shown: Our fair value estimate for Lockheed Martin stands at $432 per share. Image Source: Valuentum
Should Lockheed Martin outperform these assumptions, the top end of our fair value estimate range for LMT sits at $529 per share. That will depend in large part on the trajectory of US defense spending, which we want to stress has been resilient over the past several decades regardless of which political party is in control.
During Lockheed Martin’s latest earnings report, the firm boosted its full-year guidance for fiscal 2020 as you can see in the upcoming graphic down below. In particular, Lockheed Martin’s ‘Aeronautics’ unit has performed very well of late, which is expected to generate about two-fifths of the firm’s operating profit this fiscal year.
Image Shown: We appreciate management’s confidence in Lockheed Martin’s near-term performance, especially given the harrowing times the world is currently facing due to COVID-19. Image Source: Lockheed Martin – Second Quarter of Fiscal 2020 IR Earnings Presentation
Here is what management had to say on the issue of Lockheed Martin’s near-term outlook during the firm’s latest earnings call (lightly edited);
We have updated our full year guidance increasing our estimates for sales, earnings and operating cash flow as COVID-19 mitigation plans and our outstanding performance and minimize our year-to-date impacts. Overall, it was a strong quarter for the business in challenging times…
We have adjusted our estimates for Aeronautics, Space and RMS (Rotary and Mission Systems), increasing the midpoint of our sales range by $1.125 billion. And based on our current assessment of the full year, while COVID-19 has caused disruption in our supply chain and as some of our key locations, we have had non-COVID performance that has offset the impacts and gives us confidence to increase our 2020 outlook… And in total, we have raised the midpoint of our segment operating profit guidance by $100 million.
We appreciate management’s confidence in Lockheed Martin’s near-term performance. Farther out, Lockheed Martin’s $150.3 billion total backlog as of June 28, 2020, supports its medium-term outlook.
Lockheed Martin is a high-quality company with a nice dividend to boot. Its business model is well-positioned to ride out the storm caused by COVID-19 while keeping its growth trajectory and financials intact. We see the company offering investors a combination of capital appreciation and dividend growth upside.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice. Lockheed Martin Corporation (LMT) is included in Valuentum’s simulated Dividend Growth Newsletter portfolio.