Shares of Lockheed Martin (NYSE:LMT) climbed more than 40% from November 2016 to March of this year on investor enthusiasm over planned increases in Pentagon spending, and optimism that the long-troubled F-35 program was finally ready to soar. But the stock has actually lost 4% since the beginning of April after first-quarter results raised fears that the enthusiasm was overblown and the stock had climbed too far too fast.
Lockheed, trading at more than 30 times trailing earnings, remains at multiples nearly twice its 10-year average and is valued at a premium to most of its major rivals. But the company's second-quarter results, released July 24, provide at least some reason for hope that Lockheed Martin has room to grow into that valuation, and perhaps even power higher.
A beat and a raise
Lockheed reported second-quarter net income of $4.05 per share, easily beating the $3.92 consensus estimate despite a $0.26-per-share one-time restructuring charge. More importantly, the company raised its total-year net sales forecast to a range of $51.6 billion to $53.1 billion, up from previous guidance for $50.35 billion to $51.85 billion in revenue, and its full-year net income guidance to $16.75 to $17.05 per share, up from $15.80 to $16.10.
The reason for the increased optimism, Chief Financial Officer Bruce Tanner told analysts during a call, is that Lockheed Martin is simply winning a lot more business than it had forecast. The company for planning purposes includes a cushion to account for losses on competitions where it thinks it has a chance, but a large share of those awards have gone Lockheed Martin's way in recent months.
"We've had just a tremendous across the board year from an orders perspective so far in the first half of the year," Tanner said. The CFO said that the added business was a combination of strong win rates on "some fairly good-sized programs," including some in the classified arena, and some examples of sole-source orders that came in earlier in the year than Lockheed had originally planned.
Some of that increase is not top secret. Lockheed delivered 25 F-35 fighters in the quarter, compared to 14 in the same three months a year prior. The company has now delivered 39 for the year, and with tense negotiations with the Department of Defense on the next batch of 141 fighters reportedly nearly concluded, that business continues to be on the upswing.
Lockheed is also enjoying success in its missile business, up 17% year over year to $2.09 billion in revenue, thanks to strong demand for the PAC-3 interceptor used on the Patriot missile system. The Patriot system is the weapon of choice for U.S. allies in the Middle East and growing in popularity in Europe.
A bright future
CEO Marillyn Hewson on the call with analysts said that while the government's fiscal 2019 spending plans still need to be finalized, Lockheed Martin is "very encouraged" that its portfolio is well-positioned to show gains. Indeed, the company's raised guidance for the rest of 2018 predicts increased profit in each of its four segments, a sign that the F-35 -- though nearly 30% of total Lockheed Martin revenue -- is not the only profitable product for the contractor.
Tanner on the call said that the company is still "years away" from peak volume for the F-35, implying there is significant room for growth in what is expected to eventually be a trillion-dollar program for Lockheed and its subcontractors.
Less certain is how much of this increased business is sustainable, and how much of it is just pulled forward from future quarters. And with at least some of the increase due to post-sequestration growth in the Pentagon budget, investors need to be cautious about the upcoming midterm U.S. elections and what impact they might have on future budget negotiations.
Lockheed Martin said in April that the federal government budget deal reached earlier in the year added about $7.5 billion in potential orders for the company. On July 24, when asked if the increase can translate or carry into future years, Tanner said "the answer is absolutely yes." Given the extended lead times common on defense programs, it seems likely that at least some of the 2018 wins will flow into 2019.
Better news for holders than potential buyers
Lockheed Martin, as noted earlier, is priced at a premium to its defense rivals and trading at multiples unseen for more than a decade. The report was solid, and the outlook robust, but it doesn't make me want to buy into the company at these prices.
The big question hanging over Lockheed Martin in recent months has been whether the current valuation can be sustained, or if some regression is inevitable. The company in its second-quarter report offered a solid case that it can hold on to the gains since 2016, and if all goes right, even advance from here. That should alleviate the concerns of some shareholders who might have considered selling at these levels, but the quick 40% jump is unlikely to be repeated.
New money invested in defense today is better off put to work at some of the more reasonably valued contractors, or in the government IT sector. Lockheed Martin is a strong company and a solid hold, but the second quarter did not offer enough of an argument to buy in at these levels.