Let the shareholders rejoice: Lockheed Martin's (LMT -1.94%) F-35 Lightning II fighter jet contracts are getting bigger -- and bigger.
In September, Reuters reported on a Pentagon deal to buy what it called at the time "the biggest batch yet" of Lockheed Martin's joint strike fighter -- 141 fighter jets valued at $11.5 billion. To win such a big order, Lockheed lowered its average F-35 cost to $81.6 million. With engine and other incidental costs factored in, flyaway costs were a bit higher. Lockheed's F-35B variant flyaway cost $115.5 million, its F-35C cost $107.7 million, and the F-35A ended up at $89 million. Still, as Lockheed noted at the time, this contract offered the "lowest per-aircraft price in program history," which undoubtedly helped Lockheed seal the deal.
Big as that sale was, however, the contract Lockheed just won easily eclipses it.
In a mammoth deal announced Wednesday, the Pentagon awarded Lockheed a contract to sell 255 new F-35 fighter jets for $22.7 billion -- $89 million per plane averaged across all three models. These will include:
- 64 F-35A conventional takeoff and landing fighters for the U.S. Air Force.
- 26 short takeoff/vertical landing F-35Bs for the U.S. Marine Corps.
- 16 carrier-variant F-35Cs for the U.S. Navy.
- 131 F-35As and 18 F-35 Bs to be delivered to U.S. allies abroad.
What it means to investors (and taxpayers)
Why buy so many F-35s, and why buy so many at once? The answer to the first question is that, over the next five or so decades, the U.S. military and its allies abroad plan to buy more than 3,000 F-35 fighter jets from Lockheed Martin. This week's contract doesn't cover even one-tenth of total global demand for the stealth fighter jet -- and over time, investors should expect these contracts to get even bigger.
As for why the Pentagon decided to commission production of more than 250 planes all in one go, that's because -- as any Costco shopper can tell you -- items are often cheaper when bought in bulk. When Lockheed gets a big order for F-35s, it's able to run its factories at full capacity, negotiate volume discounts from its suppliers, and wring other efficiencies of scale from its manufacturing process. All these factors add up to savings for Lockheed Martin -- savings it can then pass along to its customers.
Speaking of savings, though, you may be wondering: If Lockheed Martin charged $89 million for an F-35A two months ago, and if this week's $22.7 billion deal also works out to $89 million per plane, then where are the savings?
The answer is a bit complex. For one thing, in the September contract, $89 million referred to the "F-35A unit price including aircraft, engine, and fee." That's how a deal that actually averaged "$81.6 million" per plane ended up costing the Pentagon $89 million, $107.7 million, and $115.5 million, respectively, for individual F-35 variants.
It's probably the devil in the details at work here, again, that explains why a much larger contract -- which should offer even greater production efficiencies and drive prices down further -- is actually resulting in a higher average cost per plane than what we saw in September. Nearly a quarter of the F-35s on order this time around will be pricier B and C variants, raising the average cost across all F-35s on order. That's probably one factor pushing up the average cost.
Even more tellingly, the majority of the F-35s being sold in this November order are being sold abroad -- and while Lockheed doesn't highlight this fact, it's generally been the case that F-35s sold abroad through the Pentagon's Foreign Military Sales program retail for higher prices than what the Pentagon pays. And that's not necessarily a bad thing for U.S. taxpayers, as it means foreign buyers may be subsidizing cheaper warplanes for us.
Whatever the reason for the apparent rise in average cost, the upshot is this: Lockheed Martin just scored a contract worth more than 40% of all the revenue it ordinarily books in a year. That revenue, moreover, will flow through Lockheed Martin's second most profitable business division -- aeronautics, which, according to S&P Global Market Intelligence data, earns a 10.7% operating profit margin.
That makes this a good deal not just for U.S. taxpayers, but for Lockheed Martin shareholders as well.