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Should You Invest In This Aerospace Contractor?

By Adnan Riaz - Sep 10, 2013 at 1:08PM

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Stocks that are mostly dependent upon government contracts will be affected the most because of defense budget cuts.

Aerospace contractor Lockheed Martin (LMT 0.33%) is largely dependent on the U.S. government, particularly the Department of Defense. As U.S. defense spending cuts loom, the company has lowered its sales expectations for 2013. With demand for fighter jets rising in foreign markets, Lockheed is now looking abroad to reduce the impact of these cuts. 

Fundamental review

Lockheed is trying to maintain earnings by cutting overhead and increasing weapons sales to other countries. The company's second-quarter earnings jumped 10% to $859 million, while revenue decreased 4% to $11.4 billion. Lockheed lifted its full-year profit forecast, and now expects earnings per share of $9.20 to $9.50 in 2013. For 2013, analysts have forecast lower sales and earnings for the company because of the reduction in U.S. military spending.

Reducing defense budget

Last year, Lockheed generated 82% of its total revenue from the U.S. government, including 61% from the Department of Defense. The company warned that this year, those sales would likely decrease by $825 million.

The U.S. government's defense budget is $526.6 billion for FY 2014, down slightly from $527.8 billion in FY 2013 and $530.4 billion in FY 2012. Among those cuts, the Defense Department has cut back its spending on Lockheed's leading fighter jet, the F-35. Further budget reductions will likely take an additional toll on Lockheed's sales.

Overseas market

To compensate, Lockheed is now focusing on overseas markets such as the Middle East and India. The company currently generates 17% of its revenue from foreign markets, wants to expand this percentage more than 20%.

Its industry peers like Raytheon (RTN) and Boeing (BA -2.84%) are generating nearly 26% and 42% of their sales, respectively, from outside the U.S. 

Raytheon expects its international sales will generate about 30% of revenue in coming years, including prospective contracts with Kuwait, Qatar and Turkey for missile defense systems and other equipment.

Besides commercial jets, Boeing, the world's largest aerospace company, also makes military aircraft. Boeing has made a bid of $7.4 billion to supply South Korea with 60 fighter jets. Boeing looks very close to winning this deal, because its bid was the only one below the price ceiling set by South Korea's arms procurement agency.

Boeing's military aircraft division also cited strong demand for its helicopters and the V-22 tiltrotor. In addition, the company said that it could sell 100 to 200 of its KC-46 tankers to international customers in coming years.

To keep up with its rivals, Lockheed is currently working in 70 countries, with a major focus in Britain, Canada, and Australia. It plans to increase focus on countries like Japan, India, Saudi Arabia, and the United Arab Emirates. The company received two contracts with a combined value of $51 million to provide military systems to the countries of Jordan and Finland.  The company expects a huge opportunity for its F-35 fighter jet from Japan and Israel.

At the Paris Air show, Lockheed signed a contract with Mitsubishi to work on the final assembly and checkout plant for the F-35 strike fighters in Japan. Lockheed didn't give the details regarding the value of that deal, but a similar contract signed with Italy to assemble F-35 jets carries an estimated value of 800 million euros, or $1.1 billion. This large number of contracts could give Lockheed good income in the future.

Liquidity problems

Lockheed carries a far larger amount of debt than its rivals. Its total debt-to-equity ratio is 884, compared to 54 and 125 for Raytheon and Boeing, respectively. The high debt may make future financing difficult for Lockheed. In the last few quarters, cash generated from the company's operating activities has also decreased; in the second quarter of 2013, it was $623 million, down from $845 million a year earlier. The company needs to reduce its debt figure to avoid liquidity problems in the future.

Bottom line

Lockheed may suffer in the short term due to federal spending cuts, but its long-term future is bright. Overseas expansion will provide a good source of income, given rising demand for aircraft in the international market. In my opinion, initiating a long position in Lockheed will give investors a healthy return.

Adnan Riaz has no position in any stocks mentioned. The Motley Fool owns shares of Lockheed Martin and Raytheon Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Lockheed Martin Corporation Stock Quote
Lockheed Martin Corporation
LMT
$441.59 (0.33%) $1.43
The Boeing Company Stock Quote
The Boeing Company
BA
$167.20 (-2.84%) $-4.88
Raytheon Company Stock Quote
Raytheon Company
RTN

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