All right, Fools. Halftime's over. Time to move into the second half of my investigation into the investment merit of large defense contractors. This all started more than a month ago when I penned a piece commenting on the seeming mispricing of the defense industry. Thus far in our examination of the defense industry's big players, I found a lot to like in the lesser-known Alliant Techsystems (NYSE: ATK ) , especially its diversified group of products and dirt cheap pricing. I advised caution with L-3 Communications (NYSE: LLL ) since it may be a possible weak link within the industry. Finally, I found much of the same with Northrop Grumman (NYSE: NOC ) showing the signs of an average business at best.
This week, my attention turns to defense titan Lockheed Martin (NYSE: LMT ) . We'll kick this potential investment's tires by delving into its long-term business prospects, financial performance, management quality, and valuation to see if it looks like the kind of bargain that helps Foolish investors beat the market.
Formed as the result of a merger in 1995 between aviation specialists Lockheed Corp. and Martin Marietta Corp., Lockheed Martin's roots reach back to the early 20th century. Today, Lockheed Martin holds a place as one of the foremost defense contractors in the world.
How Lockheed Martin functions
Lockheed organizes its businesses among four principal segments: aeronautics, electronic systems, information systems & global solutions (IS&GS), and space systems. Its aeronautics segment researches, develops, and manufactures advanced military aircraft including the popular F-35, F-16, and several unmanned air vehicles, among other products. Electronic systems creates and manages sophisticated military hardware and software platforms such as missile fire and control systems. IS&GS develops and implements highly advanced information technology systems for groups in the civil, defense, and intelligence community. Finally, the space systems division generates satellites, satellite support systems, strategic and missile defense systems, and various space transportation projects.
For fiscal 2010, Lockheed Martin generated nearly $46 billion in revenue. Its segments each contributed to Lockheed Martin's financial results in the following way:
|
Segment Name
|
2010 Revenue
|
% of Total Revenue
|
Operating Income
|
Operating Margin
|
| Aeronautics |
13,363 |
29.17% |
1,502 |
11.24% |
| Electronic systems |
15,352 |
33.52% |
1,712 |
11.15% |
| Information systems & global solutions |
10,871 |
23.72% |
890 |
8.19% |
| Space systems |
8,370 |
18.27% |
972 |
11.61% |
Source: Capital IQ, a division of Standard & Poor's. 2010 revenue figure exceeds quoted revenue figure because of excluded corporate-related costs. The same factors affect the % of total revenue figures.
Lockheed's product portfolio appears relatively well-balanced here. No one segment accounts for the lion's share of revenue. Also, three of the four operating segments produce margins higher than 10%. I certainly view that as a positive, but sitting in the low double digits doesn't overwhelm me either.
Financial performance
I also like to compare several key statistics to a company's historical performance, usually a 10-year average, to better compare the business's current footing versus its true economics. Sometimes this can provide insights into whether I can reasonably expect the business to excel or decline. Over the past decade, Lockheed generated a return on equity of 34.28% with its last three fiscal years tallying sharply higher results than the historical average. For instance, it registered a ROE of 67.50% for FY 2010. The company produced 10-year average gross and net margins of 9.19% and 4.40%, respectively, versus current rates of 10.50% for gross margins and 6.40% for net margins. The company maintained these numbers while avoiding the use of extreme leverage. For the last 10 years, Lockheed averaged a debt-to-equity ratio of 97.41%. However, it added debt over the last three years, probably because of the current rock-bottom interest rate environment. Currently total debt sits at 135.40% of equity. This could also at least partially explain the spike in the ROE figure.
Valuation
Lockheed currently trades at a price-to-earnings ratio of 11.00, 42% below its 10-year average of 26.07. This sounds dirt cheap, especially considering the stock shows some reasonably impressive performance characteristics. This places Lockheed toward the cheaper end of the spectrum of major defense contractors with Raytheon (NYSE: RTN ) , United Technologies (NYSE: UTX ) , and Boeing (NYSE: BA ) each trading at 10.75, 17.41, and 15.73 times earnings, respectively. However, some of these businesses have more robust consumer segments that insulate them from potential defense cuts and merit a greater premium from the market. Additionally, Lockheed's pricing appears all the more enticing considering the overall market's valuation current sits at 16.6 times earnings.
In addition, Lockheed's management team owns a reasonable stake in the company. While this won't guarantee success, I always like to know that those running a company have the same incentives as its owners.
Also, a legendary investing guru, Jean-Marie Eveillard, owns a meaningful stake in Lockheed Martin. While I strongly value independence in my investment analysis, seeing that some of the greats agree with you gives your investment thesis a slight shot in the arm.
Foolish final thoughts
All together, we reviewed a few of the finer points of Lockheed Martin's business and compared them to their historical averages to get a sense of what to expect from their stock. If you like what you hear, feel free to dig deeper to get the entire story. You can also leave a comment or click HERE to add Lockheed Martin to My Watchlist to receive all the latest news and analysis for your favorite stocks.
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