Shares of Lockheed Martin Corp. (LMT, Financial) are down more than 11% year to date, but the stock is essentially flat over the last year. While the share price has fallen, Lockheed remains the best name in the aerospace and defense industry. In addition, this period of consolidation has brought down the stock’s valuation, offering investors a more attractive entry point into the name.
Investors buying today are likely getting the stock at a much better valuation, leading to a total return that could reach the low double-digits. Let’s dig deeper into why I believe that Lockheed Martin is the best of breed in its industry.
Recent earnings highlights
Lockheed Martin reported second-quarter earnings results on July 18. Results came in ahead of what analysts had anticipated, with revenue growing 8.1% to $16.7 billion, beating expectations by almost $800 million. Adjusted earnings per share of $6.73 compared to $6.32 in the prior year and were 28 cents above estimates.
Lockheed Martin is composed of four business segments. By far, Aeronautics is the company’s largest contributor to revenue, though the other segments do account for a sizeable portions of sales.
Aeronautics performed well during the most recent quarter, with sales growing 17% to $6.9 billion due to increased volumes for the F-35, C-13 and classified programs. Revenue growth went straight to the bottom line as operating profit improved by the same percentage.
Missiles and Fire Control’s revenue of $2.8 billion was essentially flat year over year. Here, gains in Tactical and Strike missiles were offset by weaker volume for Integrated Air and Missile Defense. Rotary and Mission Systems declined 2.8% to $3.9 billion, mostly due to a decrease in demand for the Sikorsky division. Space grew 12.1% to $3.2 billion.
One area of concern is that the segment operating profit margin declined 30 basis points to 11.1%. That said, Lockheed Martin has a long track record growing revenue and sporting a solid profit margin.
Shareholder returns
Lockheed Martin has been a returner of capital to investors for some time because the company generates a tremendous amount of free cash flow.
Free cash flow for the second quarter was just $771 million, but amounted to $2 billion through the end of June. This total rises to $6 billion when looking at the last year. Lockheed Martin held $3.7 billion in cash and equivalents on its balance sheet as well at the end of the quarter, providing it with plenty of capital.
Dividend and share repurchases
From this cash stockpile, the company can pay its dividend and repurchase shares. The company has raised for 21 consecutive years, a streak topped by just General Dynamics Corp. (GD, Financial) and L3Harris Technologies Inc. (LHX, Financial) in the aerospace and defense industry. Since 2013, the dividend has a compound annual growth rate of more than 10%. Dividend growth has slowed slightly in the near-term, with the two most recent increases coming in at 7.1% and 7.7%. This is still a solid growth rate considering the high base the dividend is starting from.
Shares yield 2.9% presently, which compares favorably to the stock’s five-year average of 2.7% and the average yield of 1.5% for the S&P 500 Index. Lockheed Martin’s free cash flow payout ratio was 97% for the second quarter, but this droped to 76% for the first half of 2023 and is a much healthier 51% for the last 12 months. Since 2019, the average free cash flow payout ratio is 43%. Looking longer term, the dividend appears to be in good shape, though dividend growth could continue to come in slightly lower than average in the near term.
Share repurchases are another avenue for shareholder returns. Lockheed Martin has retired approximately 47 million shares since 2013, reducing the share count by nearly 15% over this period. While some companies utilize share buybacks as a means of propping up earnings growth, this is not the case for Lockheed Martin. Net income over the last decade has more than doubled.
Company's financial health
Lockheed Martin’s GF Score, which GuruFocus research has found to correlate with the long-term performances of stocks, is 89 out of 100, suggesting that returns could be modest from current levels. The company’s strongest component of the GF Score is profitability rank, where the company receives a 9 out of 10 rating from GuruFocus. Contributing factors include return on assets, return on invested capital and return on capital employed. On each metric, Lockheed Martin outperforms at least 91% of the nearly 300 companies in the aerospace and defense industry. These scores are also among the best for the last decade. Lockheed Martin has also produced 10 years of profitability for this period, which tops 99.6% of the competition.
The company posts more middling scores in most other areas, save for growth, which is mostly due to strength in revenue and book value growth. Equity-to-asset and debt-to-equity are near the bottom of the sector, but this is largely due to Lockheed Martin taking on more debt over the past few years, causing total debt to balloon to $17.5 billion as of the end of the second-quarter from $11.7 billion in 2021. Debt-to-equity is one of the worst in the industry, but in the middle of the company’s long-term history.
On the plus side, just $283 million of debt is due within the next 12 months and interest coverage is solid. The company’s Piotroski F-Score and Altman Z-Score show Lockheed Martin to be a stable company that is not at risk of going bankrupt. Lastly, the company has an impressive return on invested capital of 16.3% that is easily ahead of its weighted average cost of capital of 6%.
Valuation analysis
Lockheed Martin expects to earn approximately $27 per share in 2020. With shares hovering near $418, the forward price-earnings ratio is 15.5. Since 2013, the stock has an average price-earnings ratio of 16.4. The current multiple is also near the low end for this period. On a historical basis, Lockheed Martin appears to be trading at a discount.
The GF Value Line also shows Lockheed Martin to be slightly undervalued as well. The stock has a GF Value of $450, giving it a price-to-GF Value ratio of 0.93 and earning shares a rating of fairly valued.
Looking at the chart above, you can see that Lockheed Martin traded above its GF Value from early 2022 to just recently, implying that shares were at least slightly overvalued. Those purchasing the name during this period was paying at least a small premium for the stock.
On the other hand, investors purchasing today are likely getting a much better value. Reaching the GF Value from current levels would result in a return of 7.7%. Factoring in the dividend and total returns start to push into the low 10% range, a solid return for what I believe is the best aerospace and defense company in the market.
Final thoughts
Lockheed Martin has much going for it, including being an industry leader, solid recent results and good underlying metrics. The stock is cheap on a historical basis, but also below its GF Value. This could provide an entry point into the stock for those who had been waiting for a better value.
