Tuesday was a brilliant day for the U.S. stock market. The Nasdaq notched better than a 1% gain. The Dow jumped almost 2%. But Lockheed Martin (NYSE:LMT)? I'm afraid that was a different story.
The story at Lockheed Martin
Reporting earnings for fiscal Q4 2015, and for 2015 as a whole, Lockheed Martin beat expectations with a stick. Q4 earnings of $3.01 per share easily exceeded analysts' expectations for a $2.94 earnings quarter. Sales of $12.9 billion destroyed consensus expectations of $12.4 billion. And yet, the stock is down. Why?
To find out, let's take a step back and focus not on Q4's results in isolation, but on Lockheed Martin's full-year picture as a whole. (We only get a chance to do this once every four quarters, after all -- let's make the most of it.) In 2015, Lockheed Martin reported:
- $46.1 billion in full-year sales, a mere 1% better than it reported in fiscal 2014.
- Net income was $3.6 billion, the same as last year, so earnings didn't grow at all.
- On the other hand, continued stock buybacks concentrated earnings among fewer shares outstanding, with the result that earnings per share grew modestly -- up 2% to $11.46.
- Best of all, Lockheed Martin generated $5.1 billion in cash from operations for the year. Minus $939 million in capital spending, that left the company with $4.2 billion in free cash flow -- a 40% improvement over 2014 cash production.
Naturally, investors sold off Lockheed Martin shares by 0.5%. Hmm.
What's wrong with these numbers?
With $4.2 billion in cash profits and a $70 billion enterprise value, Lockheed Martin currently sells for an EV/FCF ratio of 16.7. That's cheap-er than the stock's 18.3 P/E ratio, but it's not cheap -- not with growth earnings rising only 2% last quarter, and not even if Lockheed manages to bump that growth rate up to the 7% that analysts are projecting for it over the next five years.
On the other hand, what if Lockheed Martin can keep growing free cash flow faster than its GAAP-calculated net earnings grow? Well, that would certainly be nice. But judging from the guidance Lockheed included in its earnings release, it's not likely to happen. This year, management is looking to grow sales as high as $51 billion (with a lot of help from its Sikorsky acquisition), but profits only 2.5%, and free cash flow -- unclear. With operating cash flow rising only to $5.3 billion, we're probably looking at a single-digit increase in FCF as well.
Long story short, the 40% growth in free cash flow that Lockheed Martin enjoyed in 2015 was a one-shot deal. Don't get used to it.
There's one final note on 2015 before we put this year in the history books. Earlier this week, we described how the production of Lockheed Martin's F-35 stealth fighter jet had accelerated to 12 planes in fiscal Q3, and we promised to check back in on Q4 production to see how well the ramp-up in production is progressing.
On that score, Lockheed noted that the 45 F-35s produced in 2015 included 14 planes produced in Q4 alone. As expected, that marked a slight increase in the pace of production from 2015. On the other hand, 14 planes also happened to be exactly the same number of F-35s Lockheed produced in Q4 of 2014. So, year over year, F-35 production didn't actually accelerate at all -- at least not in Q4.
This bit of trivia might be of particular interest to shareholders of Lockheed supplier United Technologies (NYSE:UTX). Does it imply that United Technologies might be asked to slow the pace at which it builds F135 engines, to bring engine production more in line with Lockheed's F-35 production rate?
Maybe, maybe not. But given that such a slowdown could pinch profits at the Lockheed supplier, this is something United Technologies investors will want to keep an eye on. And we shall.