With 31 F-35 Lightning II fighters delivered in the first three quarters of 2015, Lockheed Martin (NYSE:LMT) is ramping up production of its new stealth fighter jet -- and fast. But how well is key supplier United Technologies (NYSE:UTX) doing at keeping up with demand for the engines of those planes?
Lockheed Martin's 31 F-35s that were delivered through Q3 2015 were 41% more planes than it delivered to Air Force, Navy, Marine Corps, and international customers in the same three quarters one year ago. Third-quarter deliveries alone -- a dozen jets -- grew 50% year over year. At this rate, Lockheed's already on course to build four dozen planes a year in 2016. With the production rate still accelerating, it will probably build even more than that.
How many more? A recent contract secured by United Technologies holds a clue.
To see into the future, look back down the supply chain
On Jan. 15, 2016, United Technologies announced it had secured a contract from the United States Department of Defense to produce two batches of F135 engines. Each UTC-built F135 provides the "oomph" to propel one single-engine Lockheed Martin F-35 -- and the Pentagon ordered 167 engines.
As explained in UTC's announcement, the "ninth and tenth lots of F135 propulsion systems" will include units to service all of the three different F-35 variants that Lockheed Martin produces -- respectively, the Air Force's F-35A, the Marine Corp's F-35B, and the Navy's carrier-capable F-35C. Lot 9 will include 66 F135 engines, with deliveries to begin this year. Lot 10 will comprise 101 engines more, and deliveries on that lot will begin in 2017.
Now, this does not necessarily mean that Lockheed Martin will, in turn, produce 66 F-35s this year -- or 101 next year, for that matter. Already, we're seeing production of the aircraft -- and of the engines that power it -- overlap.
For example, according to Lockheed Martin, the company has delivered a total of 162 F-35 fighters to its customers since beginning production. At the same time, UTC notes that it has delivered no fewer than 262 engines for these planes.
Granted, some of those engines were probably spares. But even so, it looks like United Technologies is running ahead of schedule for its part on the F-35 program.
Dollars and cents
What do all these engine deliveries mean to United Technologies in terms of sales (and profits)? UTC holds precise pricing details close to the vest. BGA-Aeroweb estimates that the three variants of the F135 engine used by the military range from $13.75 million to $32.5 million apiece. Take the midpoint of that range ($23.1 million), multiply by 262, and it's likely that UTC has booked roughly $6.1 billion in F135 sales so far.
UTC notes that, as it improves the efficiency of its operations, and gains ever-increasing advantages from scale of production, it's driving the cost of production down. F-35A- and F-35C-variant engines are expected to cost 3.4% less by the time Lot 10 rolls off the production line than Lot 8 engines cost. F-35B-variant engines will see cost reductions of 6.4%. Very roughly, therefore, the average cost of an F135 engine appears to be trending toward $22 million per unit, implying revenues of, perhaps, $3.7 billion from the Lot 9 and 10 F135 engines.
S&P Capital IQ puts operating profit margins at Pratt & Whitney -- the UTC division that builds the F135 -- at 13.8% for the past 12 months. Accordingly, the new engine contacts should generate about $510 million in profits. That may not be as much as some of UTC's other divisions earn -- but it's a whole lot more than nothing.