Hypersonic technology -- weapons and interceptors able to travel at least five times the speed of sound -- are a top Pentagon priority and an area where China and Russia are perceived to be ahead of U.S. military efforts. The Defense Department has committed to spend aggressively to catch up. Based on initial contract awards, it's becoming clear that Lockheed Martin (NYSE:LMT) is outpacing the competition in the battle to win the lion's share of those awards.
Lockheed Martin earlier this month was awarded a $480 million contract to develop a hypersonic air-launched, rapid response weapon (ARRW). The award could be worth as much as $780 million over five years, assuming the company is authorized to move into low-rate initial production.
Lockheed beat out Boeing (NYSE:BA), Raytheon (NYSE:RTN), and Northrop Grumman (NYSE:NOC) for the award. It's the second major hypersonic win for Lockheed Martin in recent months, following a $928 million award back in April to develop a separate hypersonic conventional strike weapon (HCSW). Lockheed has also been working with NASA since 2014 to create a hypersonic version of its SR-72 spy plane, an award worth $892 million, and is developing a high-speed commercial prototype.
The Air Force views the HCSW approach as using existing technologies that have not been integrated for air-launched hypersonic weapons, while the ARRW approach is focused on developing new technologies.
A clear leader
If the awards offer the impression that Lockheed Martin is out ahead of its rivals in hypersonic development, the commentary accompanying the decision leaves little doubt. In a "justification and approval" document announcing the latest contract, military officials said that Lockheed alone is already far along in developing the air-launched booster and ordnance subsystems necessary for the ARRW program, adding that "Lockheed Martin has also already overcome industrywide staffing challenges."
In short, "no other contractor has this level of design maturity," according to the document. The government concluded it would have had to absorb up to $118 million in duplicate development costs had it selected a company other than Lockheed Martin.
Secretary of the Air Force Heather A. Wilson, in a statement announcing the latest award, made it clear that contractor readiness is an important factor. "We are going to go fast and leverage the best technology available to get hypersonic capability to the warfighter as soon as possible," Wilson said.
Is there time to catch up?
All is not lost for the other contractors. Northrop, for example, is a subcontractor on the Lockheed Martin Tactical Boost Glide program that is now part of the ARRW. And while the exact size of the potential opportunity for the industry is not yet known, these awards that Lockheed Martin has won are likely to be just the beginning.
The fiscal 2018 omnibus spending bill passed by Congress included more than $16 billion for munitions, about $2 billion more than requested, and fiscal 2019 spending will rise to $20 billion. Only a fraction of that is for hypersonic research and development. But with Russia claiming to have already deployed a hypersonic system, and China said to be nearing that point, it seems like a mini arms race has begun.
It's likely the Pentagon will do what it can to make sure the domestic hypersonic competition does not become a one-horse race. Military officials in the documentation supporting the ARRW award said that "potential competition may become available" as other contracts are awarded in hypersonics, suggesting that there are still opportunities for Northrop, Raytheon, and Boeing to get involved.
More than just the F-35
Regardless of whether others catch up, hypersonics should go a long way toward making a bull case for shares of Lockheed Martin. Hypersonics are part of a broader missile and missile-defense operation that is developing into a powerful second leg for the company. Its growth should help counter fears over the company's reliance on the F-35 Joint Strike Fighter, which currently accounts for about 30% of total company revenue and is only now beginning to ramp toward maturity.
Lockheed Martin's THAAD anti-ballistic-missile system is the deterrent of choice for the United States and its allies for dealing with potential hostile ballistic launches from North Korea and elsewhere. Lockheed also was recently awarded up to $2.9 billion to develop and begin manufacturing a fleet of infrared satellites to replace an existing system put in place to provide early detection and warning.
The company's second-quarter results came in ahead of expectations in part because, the company says, it is currently winning a lot more competitions than it had forecast. During the conference call to discuss results, management said that some of those wins were in classified areas, which likely include a healthy amount of missile and missile defense work.
Combine missiles with the F-35 ramp and add in other opportunities --including the potential for increased sales from its Sikorsky helicopter unit, an F-22 update, and even continued interest in the aging F-16 -- and it's clear Lockheed Martin is working on a powerful arsenal.
Its shares aren't cheap, up more than 50% over the past three years and trading at a defense-high 35 times earnings. But it increasingly appears the company's operations have the growth potential needed to justify its share price.
Expect shares of Lockheed Martin to maintain cruise velocity.