COVID-19 had no material impact on Lockheed Martin (LMT). With more than $140 billion worth of deals in its backlog, the company will thrive in the current environment, and its business could be considered pandemic-proof. As the US annual defense budget is expected to increase from $676 billion in 2019 to $906 billion by 2030, Lockheed Martin, as Pentagon’s biggest contractor, will undoubtedly benefit from such growth. While there’s a risk that the company could lose some of its foreign orders from the oil-rich Gulf states, which are currently suffering from the low oil price environment, Lockheed Martin will be able to offset all of those losses by winning additional defense contracts from the Department of Defense. At the same time, with more than $10 billion in debt, the company is not going to have a liquidity crisis anytime soon, as its EBIT could cover its interest expenses 13 times over. By trading at P/E of 16x, we consider Lockheed Martin to be one of the best aerospace stocks on the market right now with the potential to create value in the long run. For that reason, and because of the fact the company will be able to sustain its dividend payments with a payout ratio of more than 40% for a long time, we opened a long position in Lockheed Martin.
More Room For Growth
While the US economy entered a recession in the first half of the year and recorded the largest unemployment rate in its history, Pentagon’s biggest contractor Lockheed Martin said that the pandemic had no material impact on its business. In Q1, its revenues of $15.69 billion were up 9.4% and its GAAP EPS of $6.08 were above analysts’ estimates by $0.28. By being a defense contractor, Lockheed Martin will always outperform its civil aerospace peers during economic downturns. While companies like Boeing (BA) and Airbus (OTCPK:EADSF, OTCPK:EADSY) are experiencing order cancellations for passenger planes on a massive scale, Lockheed Martin’s businesses from aeronautics, missile and fire control, and rotary and missions systems fields are all experiencing double-digit growth. We could see from the table below that even when compared to other defense contractors, Lockheed Martin is also able to outperform them, as its operating and net margins of 13.53% and 10.21%, respectively, are above the industry’s median margins.
Source: Capital IQ
Thanks to its technical advantages against others, Lockheed Martin will continue to receive new orders from the Department of Defense and create value for its shareholders. In June, the company won a contract worth $1.04 billion for the production of guided missile systems, and just recently, it was awarded $15 billion to develop C-130J transport aircraft for the U.S. Air Force. The defense industry will continue to be the most crucial part of the national security strategy of the United States, and the country’s annual defense budget could grow to $906 billion in 2030, a 34% increase from $676 billion in 2019. The government always has much deeper pockets than businesses and consumers, and as a result, companies like Lockheed Martin, which are also crucial for the United States national security, are always going to be great investments even in turbulent times.
In recent years, Lockheed Martin has been exploring the opportunities to establish a stronger presence in space, the final frontier outside Earth. After the creation of US Space Forces in late 2019, the Congress allocated to it $15.4 billion in 2021, which accounts for nearly 60% of the NASA budget, and that number will increase over the years. As space projects become more lucrative once again, Lockheed Martin is not wasting any time and is already making progress on the space front. The Air Force Space Command already launched two of the company’s GPS Block III satellites and could purchase additional units if needed. At the same time, NASA has already ordered a dozen of the company’s Orion space capsules and is committed to purchasing more if needed. While space projects will account for a fraction of the company’s revenues, they have a high potential to become profit machines in the next couple of decades as countries around the world start to allocate more funds for space exploration.
When it comes to risks, there are a few of them. The biggest risk for Lockheed Martin’s business comes from overseas. Right now around 30% of the company’s revenues come from the oil-rich Gulf States like Saudi Arabia, Bahrain, Kuwait, and UAE. In 2017, Saudi Arabia signed a letter of intent to purchase $110 billion worth of defense equipment from the US manufacturers right away and $350 billion worth of defense equipment in the next 10 years. Two years later, the country officially signed the agreement to purchase Lockheed Martin’s THAAD missile defense systems for $15 billion. While that deal is likely to be completed, there’s now no guarantee that the rich oil state will be able to keep its promise and honor the rest of the deal in the foreseeable future considering the current low oil price environment and an ongoing recession. Saudi Arabia’s economy expects to shrink by more than 6% this year, and there’s a risk that the country will start to cancel all the other defense orders to stabilize its economy.
Another risk comes from China. Recently, the Chinese Communist Party sanctioned Lockheed Martin for its participation in a $620 million deal to ship its Patriot missile systems to Taiwan. At this point, it’s unknown how the sanctions will affect the company, but the company’s Shanghai Sikorsky Aircraft joint venture will likely be negatively affected by that decision.
While those foreign risks might hurt the company’s revenues in the short term, Lockheed Martin will be able to offset them by increasing its market share and getting additional valuable contracts back at home. At the same time, with a $144 billion worth of orders, the company will have enough time to prepare for the possible cancellation of orders and look for other customers, if needed. Even with less than $2 billion in cash and $10 billion in debt, it is not overleveraged and will not face a liquidity crisis if some orders are canceled. Right now, Lockheed Martin’s interest rate coverage is 13x, which means that its EBIT could cover its interest expenses 13 times over. At the same time, the company’s Net debt/EBITDA ratio has been decreasing in the last five years, and it now stands at 1.2x, way below its peers with similar balance sheets.
With that in mind, we should also not forget that Lockheed Martin is one of the most shareholder-friendly companies out there. Despite the ongoing pandemic, it does not need to preserve cash and continues to repurchase its shares and pay dividends to shareholders, with a payout ratio of 40%. In late June, Lockheed Martin announced that it’ll pay its quarterly dividend of $2.40 per share in late September, and those who buy its shares before September 1 will be eligible for the payment. While there’s a risk that Lockheed Martin decides to cut its dividends later on if some foreign orders are indeed canceled, such a risk is minimal, in our opinion. By trading at a P/E ratio of only 16x and expecting to generate earnings of $24.11 per share in 2020, we consider Lockheed Martin stock to be one of the most attractive, pandemic-resistant plays on the market right now. Its opportunities outweigh all the risks, in our opinion, and recently, we opened a long position in the company and plan to hold it at least for a couple of years.
Disclosure: I am/we are long LMT. 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.