Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Lockheed Martin (LMT 1.23%) shares enjoyed a modest 1.3% bump after the defense company beat earnings expectations on Tuesday. That uptick in stock price could get magnified today, however, as Wall Street begins to weigh in on the Q2 results.
So far, TheFly.com is tracking four separate increases to price targets for Lockheed Martin stock among Wall Street analysts, and a fifth ratings move -- an out-and-out upgrade from Cowen & Co. -- to boot.
Here's what you need to know.
Lockheed gave investors a close-up view of its business yesterday, and Wall Street liked what it saw. Image source: Getty Images.
Lockheed's Q2 earnings
Let's begin with a quick recap of what Lockheed Martin told us yesterday. Reporting earnings for its second quarter of fiscal 2018, Lockheed said it earned $4.05 per share on sales of $13.4 billion. Sales increased 6% year over year, while profits soared an incredible 23.5%. (Even more incredibly, profits grew so strongly despite Lockheed taking a $0.26-per-share charge for "severance and restructuring activities" in the quarter.)
Lockheed's news wasn't all good, of course. Free cash flow in the quarter was entirely negated by the company making a $2 billion contribution to its pension fund. This fact is the primary reason why, to date, Lockheed Martin has generated positive free cash flow of only $80 million this year versus positive FCF of $2.8 billion through the first six months of 2017.
Additionally, operating profit margin declined 25 basis points to 13.4% for the quarter. (The good news, however, is that thanks to a stronger Q1, Lockheed's operating profit margin for the first six months of this year is still up nearly 1 full percentage point year over year, to 14.1%.)
On a more granular level, the defense specialist experienced significant upticks in sales in three of its four divisions (space being the sole exception). Aeronautics (where Lockheed builds the F-35 stealth fighter jet) remains the company's largest division by far, with $5.3 billion in quarterly revenue -- up 8% year over year. Missiles and fire control is still the company's smallest business at $2.1 billion in quarterly revenue, but it enjoyed the strongest growth in sales -- a jump of 17%.
Profitability-wise, all four of the company's main divisions saw profits increase, with the biggest boost coming in the company's weakest division, rotary and mission systems (where Sikorsky now resides). Operating profitability there is still a subpar 9.6%, but it was up 26% year over year, a huge improvement that suggests Lockheed may be working the kinks out of Sikorsky after all.
With so much good news to report in Q2, it's unsurprising that Lockheed felt confident enough to raise guidance for the rest of this year. Lockheed now expects to earn anywhere from $16.75 to $17.05 per share on sales of between $51.6 billion and $53.1 billion this year.
What Wall Street had to say about that
Wall Street's reaction was immediate -- and enthusiastic. Bernstein, for example, cited the "strong" results as justification for raising its price target on Lockheed Martin stock to $356. Morgan Stanley went a step further, hiking its target to $377 and citing a "potential" for "multi-year" earnings improvement.
Credit Suisse liked both the results and the potential, saying the company's "strong quarter and ... strong guide" gave it confidence to raise its price target to $340. And Stifel Nicolaus, while concerned about the state of Lockheed's cash flow, nonetheless hiked its target to $400.
But what about Cowen & Co., the only analyst (so far) to actually upgrade Lockheed Martin stock on yesterday's news? Cowen's statement is curious -- and optimistic. On the one hand, the analyst claims what I'd argue was a weak point in Lockheed's report -- its cash flow -- was actually a strength. In a note covered on StreetInsider.com (subscription required), Cowen cited "[a]bove-average cash flow/dividend yields" at Lockheed as a reason to own the stock. (Note that while Lockheed had trouble with cash flow in Q2, Lockheed's dividend yield of 2.6% is in fact significantly higher than the market average of 2%.)
Harking back to Morgan Stanley's statement about Lockheed's "multi-year" potential, Cowen also argues that it sees Lockheed growing its earnings at 10% annually through 2021 -- about a quarter higher than the consensus 8% growth rate reported by S&P Global Market Intelligence. In the analyst's opinion, this is good enough to justify an outperform rating and a target price of $370 a share, or 16% higher than where it sits today.
Valuing Lockheed Martin stock
But is a 10% growth rate really enough to justify buying Lockheed Martin stock? I'd argue not -- and here's why:
Lockheed Martin currently carries a $91.6 billion market capitalization. (It also carries $11.8 billion in net debt, I should mention, which gives the stock an even richer $103.4 billion enterprise value.) Even valued on market cap alone, though, Lockheed's $2.6 billion in trailing earnings values the stock at more than 35 times earnings.
Traditionally, value investors shouldn't want to own a stock so richly priced unless its earnings growth rate, too, is well into the 30s. A 10% growth rate, therefore, simply isn't good enough to entice me to buy the stock. On top of that, Lockheed Martin stock sells for 1.75 times sales -- about 75% above its long-term average -- which I take as a second indication that the stock is overpriced.
Lockheed Martin did have a fantastic quarter. But for me, this story boils down to: Great business, but the stock costs too much.
