Why did investors forgive Lockheed Martin for its miss? Part of the reason probably owes to revenue, which exceeded expectations in each of Lockheed's business segments. But you can find other explanations for investors' bullishness about LockMart in the company's post-earnings Q4 conference call with analysts.
Here are five noteworthy updates that Lockheed management provided in that call and what they mean for you as an investor.
1. The F-35 has momentum
We delivered our 91st F-35 aircraft of the year on December 20th, meeting our 2018 target and exceeding our 2017 deliveries by 25 jets, an increase of nearly 40%. ... The announcement of our F-35 production lots 12, 13 and 14 [add] an incremental value of approximately $19 billion, adding over 250 aircrafts to our backlog. Our F-35 aircraft backlog has grown to nearly 400 planes. -- Lockheed Martin CEO Marillyn Hewson
So, yeah, F-35's got a real good cadence. ... we got more aircraft at the end of the year in terms of backlog than we delivered since the inception of the program. -- (retiring) Lockheed Martin CFO Bruce Tanner
It's hard to overstate just how important Lockheed Martin's F-35 Lightning II stealth fighter program is to the future of this company. Valued in excess of $1.3 trillion in expected worldwide sales over its lifetime, the F-35 probably accounts for more than 25% of Lockheed's annual revenue today, and should exceed 50% of total revenue as production ramps up.
With 400 planes in backlog today, Lockheed is rapidly fulfilling the promise of the F-35, and scaling up nicely in a manner that should yield production efficiencies, lower prices, and, if all goes as planned, more sales as the cheaper plane attracts even more buyers abroad.
F-35 has the margins
I would expect [F-35] margins to maybe increase 50-plus basis points over what we saw in 2018 as we sort of get to a more steady-state ... margin similar to our experience on other production programs in our portfolios, including F-16, F-22 and C-130s and the like. -- Tanner
But hold up a sec. Won't "cheaper F-35s" imply lower profit margins for Lockheed Martin, and make Lockheed Martin stock less attractive as an investment? Not according to Tanner.
Lockheed Martin holds margin data on specific weapons programs pretty close to the vest, so it's difficult to know exactly what profit margin Lockheed is targeting for F-35. Still, just a few years ago defense analyst Loren Thompson (who consults for Lockheed and ought to know) let slip that "Lockheed Martin has never gotten above a 9% profit margin" on the F-35.
If we assume, as seems logical, that F-35 profit margins are going up as the program gains scale, and take that "9%" as our benchmark, this implies that Lockheed's F-35 program is now on track to hit 9.5% sometime this year, and is rapidly approaching parity with the company's overall 10.6% operating profit margin for Aeronautics sales (as reported by S&P Global Market Intelligence). Once it gets there, I'd say it will be safe to call the program "mature," and with F-35 on track to account for half Lockheed's business, I'd say that profit margins overall should look pretty secure.
Don't forget the F-16!
International community expressed their continued interest in our legacy F-16 pilot program for those upgrades and new production units of our Viper Aircraft configuration. Our aero team closed on an opportunity with Greece to modernize 85 of their current F-16 fleet to this advanced platform ... The Bulgarian Ministry of Defense announced their intent to procure eight new jets. Once the contract is finalized and definitized, Bulgaria will join Bahrain and Slovakia as new F-16 customers, extending our backlog of Fighting Falcons well into the mid-2020s. -- Hewson
For the time being, of course, as the F-35 program gets up to speed, Lockheed still depends on sales of the world's (still) best-selling fighter jet to help keep its profit margins strong. With 2,269 Lockheed Martin F-16s in service around the world, the aerospace analysts at Flightglobal confirm that for the umpteenth year in a row the F-16 remains the world's most popular fighter. And as Hewson points out, Lockheed's F-16 program still has legs.
Granted, over time outright sales of the F-35 will eventually begin replacing sales of the F-16 in more advanced markets. Still, upgrades of existing F-16 fleets should provide a continuing legacy income stream to Lockheed. And with DefensePost.com reporting that the Greek F-16 upgrades, for example, will cost $1.45 billion, this is not small change for Lockheed Martin.
Lockheed at sea
We were very pleased to be selected by the Royal Canadian Navy as a member of Canada's combat ship team to be their preferred bidder to begin design work for the future fleet of Canadian Service Combatant ships. Lockheed Martin Canada will be the combat systems integrator and provide the combat management system ... A total of 15 ships are planned to be built to replace Canada's Iroquois-class destroyer and Halifax-class frigates and will form the backbone of Canada's maritime combat power for decades to come. The Canadian Service Combatant Program is the largest defense project ever undertaken by the government of Canada. And when completed, the RMS team could see orders totaling approximately $7 billion for their role in this effort. -- Hewson
Shifting gears and combat theaters, Lockheed's CEO gave us valuable insight into the company's lower profile but still important -- $7 billion is a big number -- warship business (which Lockheed curiously groups together with helicopters under its Rotary and Mission Systems division).
CBC Canada reported Lockheed's Canadian Combatant warship win -- which we've been following here for years -- late last year. Briefly, Canada has chosen to build a new fleet of warships based on BAE Systems' Type 26 Global Combat Ship. Although usually described as a "frigate," the Type 26 displaces 6,900 metric tons, and is 50% bigger than America's old Oliver Hazard Perry-class frigates -- in fact, it's about as big as an American Arleigh Burke-class destroyer.
So this is a significant warship, and Canada is planning to spend a significant sum building it, about $45.5 billion for a fleet of 15 vessels, or roughly $3 billion per warship. Although Lockheed Martin will not get all of this loot, $7 billion in revenue, at the 9.15% operating profit margin that RMS generates for Lockheed, should yield upwards of $640 million in profit for Lockheed over the life of this program.
Lockheed in space
Space [was] impacted this year by lower equity earnings at ULA as we discussed on the last call. ... [If] we talked about Aeronautics growing at the high single-digit [rate], space [will show only] very slight growth." -- Tanner
I'll have to end today's sum-up of Lockheed Martin's Q4 conference call on a down note.
Although best known for its fighter jets, Lockheed Martin is also one of the country's largest space contractors. Lockheed's space business includes both things like satellites and missile defense systems that it builds itself, and also income from Lockheed's "United Launch Alliance" joint venture with Boeing. It's this latter business that Tanner discussed in both Lockheed's Q4 and also its Q3 conference calls.
Here's a quick refresher on what he said three months ago:
We also expect to have lower equity earnings associated with ULA business as a result of the number and mix of launches expected in 2019 compared with 2018. ... The largest single item that is driving the margin reduction next year though is actually our ULA equity earnings. ... We expect those to be down nearly $150 million or so from this year's estimate of the equity earnings from ULA [because of] a pretty significant reduction in both the launch quantity in terms of the number of vehicles launched [and also] a pretty significant change in the mix of those launch vehicles. We have more, for instance, Delta IV launches in 2018 than we expect to have in 2019. Those are obviously the most profitable launch vehicles in all of ULA's portfolio. So that's the biggest driver.
What are the big takeaways here? Well, first of all, Lockheed just confirmed to us something that seems logical on its face, but wasn't necessarily known for sure: United Launch Alliance (and Lockheed) earn more profit from launching expensive Delta IV rockets (priced at $350 million and up) than from launching Atlas V rockets that can cost half that. The more Delta IVs ULA launches, the more money Lockheed makes -- but unfortunately, it seems the opposite of that is true as well.
And second, do you remember that last year we told you about space market researcher StratSpace, and its warning that the market for large satellite launches is flatlining, and that "small missions and spacecraft will gradually begin to displace" launches of larger satellites -- the kind that might need Delta IVs to lift them?
Well, it seems Lockheed Martin is confirming that prediction. So far, all Lockheed is admitting to is a decline in the pace of large rocket launches from 2018 to 2019, but StratSpace thinks this is a longer-term trend, not a one-year blip.
Lockheed Martin shareholders: Beware, and be forewarned.
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