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Despite Recent Progress Lockheed Martin Faces Some Challenges

by: Matthew Potter
July 4, 2012

Category: Business Line, Companies, Congress, Department of Defense, development program, Events, Federal Budget Process, General Dynamics, Lockheed Martin, Military Aviation, Northrop Grumman Corp., production program, Raytheon, Services | RSS 2.0

Lockheed Martin (LMT) remains the largest defense contractor in the United States as well as globally. It is responsible for the biggest military acquisition program in the history of the world – the F-35 Joint Strike Fighter (JSF) as well as several other major aircraft and hardware systems. The company has consistently done well with its earnings and maintained a high dividend.

The Lockheed stock seems attractive right now. Price as of 29 June was $87.08. It has outperformed the market by 6 percent over the last year, its P/E is a little above 10 and it pays a dividend of $4.00 a year. The major defense contractors like LMT or Northrop Grumman (NOC), Raytheon (RTN) and General Dynamics (GD) have consistently increased their dividend over time. The companies have also focused on reducing their costs to boost profit margins as well as make them more competitive with the Pentagon when it comes to price meaning as long as defense spending remains fairly consistent there should be increases in earnings and profit as these trends continue.

Lockheed has moved to reduce its workforce especially those in the middle management or overhead positions. It has also when possible adjusted its pension plans and negotiated new contracts with its unionized workers to lower personnel costs when possible. It’s most recent quarter set it apart from its competitors as the company had both growth in earnings and revenue. Most others had seen earnings up but on a revenue drop as their efforts to reduce overhead and cost of providing their products helped.

As the Pentagon continues to execute its Fiscal Year (FY) 12 budget plans new contracts are competed and awarded with Lockheed winning their fair share of them. Yet the future of defense spending is clouded with uncertainty due to the plans for FY13 spending caused by sequestration. Sequestration is automatic budget cuts of up to $100 billion a year in defense spending due to the failure of the Obama Administration and Congress to reach a budget deal last year. All acknowledge that these cuts would have a severe effect on the military, its contractors and the U.S. economy in general yet without changing the current law they will occur.

Lockheed just finally settled a major strike by its Dallas-Fort Worth aircraft assembly workers. This lasted over two months and was driven by Lockheed’s request for them to cut their pension plans. These workers make the F-35 and the F-16 fighters which are a large portion of Lockheed’s portfolio. The key part of the new contract as stated in the press release is “The agreement compensates union members fairly while allowing Lockheed Martin Aeronautics to be competitive for new contracts and respond to customer demands for greater affordability in defense products.” The settlement of this action will allow Lockheed to focus on delivery of the aircraft.

Other then the potential budgetary issues facing the industry as a whole Lockheed does raise some concerns. It has a large debt and pension obligation due to a large workforce and a more traditional defined benefit plan. The Pentagon recently announced that due to concerns with Lockheed Earned Value Management System (EVMS), which tracks cost and schedule data, it will now withhold up to 5 percent of payments. This is the maximum penalty that may be applied. The EVMS for the F-35 is the major concern which is a program that faces scrutiny of its costs and schedule from Congress. If Lockheed cannot get its system into compliance then it faces a potential hit to its earnings and profits as the F-35 program is so large.

Congress has already made some moves to keep parts of the budget recommended for cuts by the Obama Administration. (http://seekingalpha.com/article/566861-defense-contractors-aided-by-congress-keeping-money-in-defense-budget) It may be expected that these will continue. Sequestration is designed to prevent Congress from doing this which is why all are focused on ways to prevent it or minimize the effect on defense spending. Too many jobs, and votes, are affected by it. That does not mean that there will be success in preventing the reduced spending. The U.S. deficits are recognized as too high and something must be done.

Lockheed stock due to its current price, dividend and their large contracts should probably continue outperform the market over the next few months. Until the full effects of sequestration or efforts by Congress to minimize cuts to defense spending are identified there should be no major movement of the price. If the worst case happens and the U.S. faces cuts to defense spending in the range of $50-100 billion a year Lockheed should at least see some short term pain. If the plan is changed and defense spending is protected then this stock along with the other defense industrial stocks should see some increase. This, though, won’t occur until 2013 and the stock like most of its competitors really remains a dividend buy only.

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