As 2015 dawns, everything is playing out according to plan for Lockheed Martin (NYSE:LMT) -- but that's not necessarily a good thing.
Three months ago, reviewing Lockheed's 2014 year-end results, we noted that in the current year, Lockheed Martin was predicting that 2015 would see declines in revenues (ranging from $43.5 billion-$45 billion) and earnings ($10.80-$11.10 per diluted share). Three months later, here's how things are shaping up, based on Lockheed Martin's latest earnings release:
- Q1 sales amounted to only $10.1 billion, down 5% year over year and about 1% below analyst estimates.
- Operating profits dropped a similar 5%, and net earnings for the company were down 6% at $878 million.
- And cash from operations nosedived from $2.1 billion a year ago, to less than $1 billion in Q1 2015. Combined with higher capital spending, this left Lockheed Martin with free cash flow of just $839 million for the quarter -- a 58% year-over-year decline.
Aside from that, Mrs. Lincoln, how was the play?
So why is the stock up this morning, despite the generally miserable news?
That's actually an excellent question, and one only partially explained by the fact that Lockheed's per-share diluted profit of $2.74 exceeded analyst targets of $2.50 per share. Fact is, on a per share basis, Lockheed's profits were down nearly 5%. And the only thing that prevented them from tracking the net profit down even further, was the fact that Lockheed spent more than $600 million during the quarter, buying back 3 million of its own shares.
But was this a good thing? I'd argue not.
Consider: The 3 million shares that Lockheed bought cost the company an average of $201 and change each. With Lockheed Martin stock currently trading below the $200 line, that doesn't look like a particularly astute investment, even if it did deliver for the company an artificial earnings "beat." What's more, Lockheed's reliance on share buybacks to slow the decline in both revenues and profits suggests management's guidance "upgrade" -- earnings now expected to be a nickel-a-share more profitable than previously expected, and ranging from $10.85-$11.15 for the year -- isn't really worth cheering about, either.
The upshot for investors
So where does all this leave Lockheed Martin shareholders? Briefly, the situation looks like this:
Taking Lockheed at its word, and assuming mid-range earnings of $11 per diluted share in 2015, Lockheed Martin stock now sells for about 17.9 times earnings. The stock pays a 3% dividend yield, and most analysts expect to see Lockheed post sub-industry-average earnings growth of just 9% annually over the next five years.
This all works out to about a 2.0 PEG ratio on Lockheed Martin stock, and a total return ratio (P/E, divided by the sum of earnings growth and dividend yield) of perhaps 1.5, which seems rather pricey. At the same time, Lockheed's $62 billion market cap, when weighed against its likely $44.25 billion in 2015 sales, gives Lockheed Martin stock a price-to-sales ratio of 1.4 -- about 40% above what I've argued in the past is the "natural" valuation for a defense contracting stock.
Long story short: Lockheed Martin stock is overpriced today. Investors who have responded to the earnings news by rushing to buy, are heading exactly the wrong way.