Lockheed Martin Corporation Earnings Surge, but Share Price Sinks

The good news: The stock price is starting to look attractive again.

Apr 23, 2014 at 1:13PM

Shares of Lockheed Martin Corporation (NYSE:LMT) sat out Monday's rally on the Dow, and actually declined 3% in reaction to the company's Q1 earnings report Tuesday. What spooked investors out of this premier name in defense contracting? Let's find out.

In Q1 2014, Lockheed reported that:

  • Sales declined 4% to $10.7 billion, and fell a bit short of analysts' estimated $10.9 billion.
  • Operating profit margins across Lockheed's several business segments, however, averaged 13.4%, a 130-basis-point improvement over last year's Q1 operating profit margin of 12.1%.
  • Profits per diluted share rose an astounding 23% to $2.87, far in excess of the anticipated $2.53 per share profit, despite the weaker revenues.

Best of all, the earnings that Lockheed reported were of exceedingly high quality this quarter. Against $933 million in "GAAP" net profits, the company reported $2.1 billion in cash from operations, and spent only $103 million of that on capital expenditures -- a clean $2 billion in free cash flow for the quarter.

And judging from the company's update on its expectations for the remainder of this year -- orders and revenues unchanged from the company's January update, but operating, net profits, and cash from operations all ticking up modestly, free cash flow for the whole of fiscal 2014 should be equally good -- perhaps $3.9 billion when all's said and done.

Assuming that is the way things will play out, investors would be looking at:

  • a stock selling for just 12.8 times annual free cash flow
  • expected 8.6% annual growth (but with the capacity to surprise us -- did I mention that profits surged 23% in Q1?)
  • a generous 3.3% dividend yield

Is this stock a bargain?
That all looks pretty good to me. Not a screaming bargain, granted, but a very fair price for a very good company. And with Lockheed being the largest pure-play defense contractor in America, it's a company with an exceedingly wide and deep "moat" around its business as well.

So why did investors flee the stock Tuesday? The answer basically comes down to one line in the company's earnings report: Namely, the "top line," where revenues fell 4%, and where Lockheed warned investors to expect further revenue declines as the U.S. government tightens its defense spending belt. Backlog at Lockheed has shrunk more than 3% over just the past three months, too. That's a trend that promises shrinking revenue even worse than the 6% reduction in military sales that Lockheed has already warned us about, if it continues.

Or not
The key thing to think about when pondering an investment in Lockheed, though, is that this is more than just a defense company. This is a company, period. A company that can focus on selling defense products, when those are most profitable -- but also a company free to explore other business ventures, if the defense business gets bad. A few months ago, I laid out just a few of Lockheed's new initiatives to seek out revenues "wherever they're at," be this in water desalination to ease California's drought problems, in green energy, or elsewhere.

At today's share price, I'm of the opinion that investors may be focusing too intently on Lockheed's role as the nation's premier defense contractor, and ignoring the company's ability to bob and weave into other business ventures as business conditions necessitate. While the stock's not quite cheap enough to entice me to buy just yet, a bit more negativity on Wall Street's part could help it get there. 

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As every savvy investor knows, Warren Buffett didn't make billions by betting on half-baked stocks. He isolated his best few ideas, bet big, and rode them to riches, hardly ever selling. Investors tempted to sell Lockheed Martin out of fear that the defense business is in near-term peril might want to take a lesson from that. They might also want to take a few tips from legendary investor, and The Motley Fool co-founder Tom Gardner, who recently revealed his own list of The Motley Fool's 3 Stocks to Own Forever. These picks are free today! Just click here now to uncover the three companies we love. 

Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of Lockheed Martin. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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