When you think of Lockheed Martin (LMT 0.77%), the aerospace and defense giant, what comes to mind first? Fighter jets, probably -- F-16s and F-22s and F-35s (oh my!). Helicopters, probably -- if you're aware that Lockheed now owns Sikorsky. And spaceships, maybe -- because Lockheed Martin's Orion space capsule will soon sail past the moon, if NASA can ever get its Space Launch System off the ground.
But whatever you think when you hear "Lockheed Martin," I'd bet good money that you don't think about sonobuoys.
Ping! Can you hear me now?
And yet, the defense giant was named just this week as one of three recipients of a gigantic $5.1 billion contract -- one of the largest awards of its kind in recent memory -- to manufacture probably thousands of sonobuoys for the United States Navy over the next five years.
That's right. Sonobuoys are the humble floating electronic devices that Navy warships and aircraft drop into the water to help detect and track enemy submarines. They're priced at roughly $1,000 per unit, so you might not think sonobuoy sales would be very important to Lockheed Martin with its $64 billion in annual revenues. But when bought in bulk (and the Navy buys a boatload every year), they can really add up.
In 2019, for example, the Navy awarded a $1 billion contract for the production of 932,500 sonobuoys of various types. Over the past five years, total Navy contracts for the production of sonobuoys was approximately $2.3 billion.
Now, $2.3 billion sounds like a lot of money. But on Oct. 3, 2022, in one fell swoop, the Navy more than doubled that number. For $5.1 billion, it contracted not only Britain's Undersea Sensor Systems (USSI) and Israel's Elbit Systems subsidiary Sparton Corporation (historically its two biggest providers), but Lockheed Martin, too, to meet its sonobuoy needs for the next five years. At historical prices, $5.1 billion probably equates to something on the order of 5 million sonobuoys ... or 1 million per year.
Lessons from Ukraine
Why would the Navy want to buy so many buoys? Retired Navy Capt. Henry J. Hendrix, now a senior fellow at the Sagamore Institute, says there are two main reasons: First, the Navy didn't buy enough sonobuoys in years past and now needs to play catch-up. And second, the U.S. is on the cusp of "a great power competition with two nations, China and Russia, who are investing more in submarines" -- such that we may need even more sonobuoys in years to come.
In this regard, the Navy may also be drawing lessons from the Army, which has seen its stockpiles of rockets, missiles, and especially artillery rounds seriously depleted by donations to Ukraine this year. The rapid rate at which munitions were expended there has the Pentagon worrying that, in the event of a conflict with an adversary with a large submarine force, the Navy might encounter similar deficits in sonobuoy supply.
Rather than let that happen, the Navy is getting ahead of the problem and stocking up on sonobuoys today.
What this means to investors
Whatever the reason for the contract, it appears to have largely slipped beneath the radar (sonar?) of the financial press -- which may provide an opportunity for investors in Lockheed Martin.
As large as Lockheed is, it hasn't historically been a big player in the sonobuoy market. (Usually, sonobuoy contracts go to Sparton, USSI, or ERAPSCO -- which S&P Global Market Intelligence describes as a joint venture between Sparton and USSI). Lockheed seems to have begun getting involved in this market only in 2018, and only at a small volume. It was a natural product extension, seeing as Lockheed had just recently acquired Sikorsky with its stable of sub-hunting "Seahawk" helicopters. But up until this week, that hadn't translated into large sonobuoy orders for Lockheed.
That may change with this contract, however. Granted, not all of the $5.1 billion awarded will go to Lockheed. Sparton and USSI will certainly compete for their share(s) of the pie. But for every $1 billion in sonobuoy revenue that goes to Lockheed, at the company's 7.3% net profit margin, roughly $0.30 per share could drop to Lockheed's bottom line -- potentially enough extra profit to make the difference between an earnings miss and an earnings beat for the defense giant.
Wall Street doesn't seem to be factoring this into its forecasts for Lockheed yet. But maybe you should.