The ongoing drama of Lockheed Martin's (NYSE:LMT) F-35 fighter project – and the company's head-butting with the Pentagon – is Wall Street's biggest defense story. After a year of squabbling and negotiations between the two sides over a deal for the next batch of ordered planes, finally a deal may be coming together. Defense Undersecretary Frank Kendall, in a conversation with Reuters, claimed to have a "very positive" meeting with incoming Lockheed CEO Marillyn Hewson, in addition to commenting on the deal by saying, "I think we're getting very close."
It's a good sign in a season of change for Lockheed – and despite the frenzy over the ballooning costs to the F-35, Lockheed looks ready to finally get back on track.
Shaking up the status quo
I certainly haven't hid my optimism in the Pentagon's costliest project and its contractor, but while the past year hasn't been kind to Pentagon-Lockheed negotiations, Kendall's words aren't just talking points. Hewson's arrival as CEO signals a turning of the page for Lockheed, and getting off on the right foot with the Defense Department is just what she needs to anchor a strong foundation with the Pentagon.
If Hewson can build upon that rapport, it could mean far more for the company than just the continued success of the F-35. Lockheed's done well in both cyber systems and electronics recently, and a strong relationship could help the company beat out the likes of sturdy rivals Raytheon (NYSE:RTN), L-3 Communications (NYSE:LLL), and others in those promising areas that have come to make up a significant portion of Lockheed's revenues.
But back to the fighter: The Pentagon's been holding funds for a sixth order batch of F-35s until this deal is struck. Freeing up the Pentagon's funding for the sixth batch of fighters is especially important in light of Lockheed's warning in October that it could face a $1.1 billion charge if the current deal is further delayed.
Since Lockheed hasn't recorded a new batch procurement order from the DoD in more than a year – its last orders came from international partners such as Norway – landing this deal is important before the fiscal cliff (potentially) strikes.
Budget concerns going nowhere
While sequestration won't likely have the apocalyptic impact on Lockheed that some claim for the defense industry, it's imperative that the company makes some progress now before budget cuts start falling. Even if the automatic cuts of the fiscal cliff and sequestration don't come to pass, the DoD's in line for some cuts after its budget has reached record levels recently.
Unfortunately, it's likely that those expected cuts will slim down some future F-35 orders, as the Air Force's goal of buying 80 aircraft a year starting in 2021 would provide an excess of aircraft. A similar fate befell Lockheed and Boeing's (NYSE:BA) F-22 fighter, when original order projections were severely downsized. Don't expect the same sort of drastic reductions with the do-everything F-35, but with domestic budgets tightening and uncertainty over sales overseas – South Korea, which has been considering the F-35 for its air fleet, could delay its nearly $7 billion fighter competition – it's reasonable to expect some downsizing.
Time for some progress
Nevertheless, progress on the latest deal is just what Lockheed needs – and all the better that the DoD and Hewson have managed to find common ground after the disastrous year these two parties have had. If Lockheed's new CEO can continue to smooth over relations with the Pentagon, expect good things from the defense sector's largest player.