Shares of Lockheed Martin (NYSE:LMT) flew past a diving Dow yesterday and ended around 9% down for the day. If catching a falling knife is tricky, how much harder will it be for investors to bag a falling F-35 Lightning II?
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By all indications, Lockheed had a slow third quarter. At midyear, the company was boasting of 6% sales growth and 14% more profits per share than it earned in the first half of 2007. Three months closer to year's end, we're now looking at just 2% sales growth but still a healthy 12% rise in earnings per share -- so three's a bit of a slowdown, but hardly the stuff that 9% sell-offs are usually made of.
It must have been something else that spooked the market yesterday. Maybe it was the warning that the explosion of America's equity markets just blew a hole in Lockheed's pension plan. Yesterday, in an interview with MarketWatch, Lockheed's CFO advised that the company's pension plan has dropped by 25% in value over the last month and a half. Unless things turn around in a hurry, management expects that it will have to contribute $100 million next year to bridge the gap between expectations and the reality of its pension fund's growth trajectory.
In related news, Morgan Stanley (NYSE:MS), citing the risk of similar pension shortfalls as one factor in its downgrades, warned investors yesterday to avoid Lockheed rivals such as United Technologies (NYSE:UTX).
$100 million? That sounds like a lot ...
I know it does. Yet for a $40 billion-plus revenue creator like Lockheed, it really isn't. To Lockheed, it's more of a rounding error. The company's still expecting to generate $4.3 billion in operating cash flow this year, and another $4 billion or more next year. I'd say, judging from historical capital-spending trends, this leaves the company with some $3 billion in cool, hard, free cash flows next year -- even after patching its pension shortfall.
At today's price, that works out to a price-to-free cash flow ratio of 11, which seems fair relative to analyst growth expectations (12% long term). It's perhaps more than fair, for a chance to own one of the world's largest defense contractors, along with peers such as General Dynamics (NYSE:GD) and Raytheon (NYSE:RTN).
Nor do I think those growth expectations are overly optimistic. Although sales are up only 2% so far this year, backlog has grown more than twice as quickly -- a suggestion that faster sales growth lies ahead. And if Lockheed can grow profits at 12% on 2% sales growth, just imagine what it can do if the company's sales accelerate.
Foolish takeaway
My guess: Lockheed will regain its lost altitude, and perhaps more rapidly than we think.
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