Foolish Forecast: Lockheed As Death Star

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Earnings season opens with a bang this week -- the nation's arms makers form ranks and belt out their earnings stats for fiscal Q4 2007. United Technologies (NYSE: UTX) and General Dynamics (NYSE: GD) reported for reveille this morning, and before the month is through, we'll have heard from 'most everybody who's anybody in defense contracting.

Today, we've got Lockheed Martin (NYSE: LMT) on our radar. So let's examine where it's been, where it's going, and what Lockheed has in common with Star Wars' Death Star.

What analysts say:

• Buy, sell, or waffle? Twenty analysts keep Lockheed on their radar. Twelve rate it a buy, and eight say hold.
• Revenue. On average, they're looking for flat quarterly sales of about $10.8 billion.
• Earnings. Profits may eke out a 1% increase to $1.70 per share.

What management says:
Citing "double-digit growth in sales and operating earnings for every business segment" in Q3, CEO Bob Stevens argued that investors should love Lockheed for its "consistently strong operational and financial performance." That wasn't the case last quarter, however, as investors peered past fiscal 2007 performance and pondered the perils the future might hold -- namely, a slowdown in F-16 sales and a lull in new business pending large-scale purchases of Lockheed's new F-35 Lightning II warplane.

What management does:
Which is a crying shame, because it means Lockheed isn't getting the respect it deserves for admirable performance in years past. Gross and net margins have been on the rise for more than 18 months now, and the operating margin for more than a year -- putting the company neck-and-neck with Raytheon (NYSE: RTN) and maintaining its sizeable lead over archrival Boeing (NYSE: BA) in operating profitability. Yet as Lockheed expanded its net margins 16% over the past 12 months, the stock gained a mere 5%.

Margins	6/06	9/06	12/06	3/07	6/07	9/07
Gross	9.3%	9.5%	9.9%	10.1%	10.4%	10.7%
Operating	8.1%	7.6%	8.6%	9.0%	9.3%	10.0%
Net	5.6%	6.1%	6.4%	6.6%	7.0%	7.1%

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
Are investors overreacting to the F-16 fears? I'm not so sure. This earnings season, I'm running down the "backlog" numbers at all of the major defense contractors, in hopes of finding clues to what their futures might hold. While Lockheed isn't as shareholder-friendly as contractors like Northrop Grumman (NYSE: NOC) or SAIC (NYSE: SAI), which break out the funded and unfunded portions of their backlog, it does give us the "total" of these two sums. Let's compare how Lockheed's backlog has been moving relative to its sales:

	Q3 2005	Q3 2006	Q3 2007
Total backlog	$69.1 billion	$77.9 billion	$72.7 billion
YTD revenue	$27.0 billion	$28.8 billion	$31.0 billion

To paraphrase Grand Moff Tarkin, I suspect investors may be correctly estimating the risk of a stall-out at Lockheed. As you can see, sales have grown about 15% and the backlog has grown about 5% over the past two years. Worse, backlog actually declined between Q3 2006 and Q3 2007. As backlog by its very definition represents potential "future sales," what we're seeing here is that Lockheed's past shines brighter than its future. Or as Death Star Commander No. 1 might have put it: "We've analyzed their attack, sir, and there is a danger."

Just in case things get worse before they get better, I'd suggest you keep your ship standing by.

Read up on recent Lockheed news in:

• EADS Takes Ball, Goes Home
• Lockheed's Plane for All Seasons
• Lockheed in Final Approach