We maintained our long-term Neutral recommendation on aerospace and defense major Lockheed Martin Corporation (LMT) on May 10, 2013. The company’s first quarter 2013 results and its leveraged presence in the Army, Air Force, Navy and IT programs are somewhat undermined by its operational dependency on the US government and cuts in defense spending.
Why Kept Neutral?
The world’s largest U.S. defense contractor, Lockheed Martin reported strong first quarter 2013 earnings that surpassed our expectations by 23.4%. Earnings in the reported quarter also surged 2.5% from the year-ago adjusted profit level. The upcast in earnings was mainly attributed to lower tax expenses.
Lockheed Martin continues to benefit from strong defense spending on a number of its platform programs like the C-130 Hercules & C-5 Galaxy transport aircrafts, the Global Positioning Satellite III (GPS III) system satellites, the Littoral Combat Ship (LCS), the Terminal High Altitude Area Defense (THAAD) system and many others.
The company is a well-managed defense major. Its working capital improvements continue to impress, as is evident from its inventory turnover of 15.2 times in the trailing twelve months at the end of the first quarter, compared to only 2.8 times for the Zacks industry average, showing a strong sign of operational efficiency.
In addition, Lockheed Martin’s operational effectiveness is evident in its industry-high Return on Investment (ROI) of 38.7%. This will aid the company to accomplish its long-term goal of 5%–7% revenue growth. Lockheed Martin affirmed its full-year 2013 earnings per share guidance of $8.80–$9.10.
Management is also prudent in returning a substantial portion of its free cash flow to shareholders through share repurchases and incremental dividends. It booked free cash flow of roughly $1.9 billion during the first quarter and utilized roughly $900 million for stock buybacks and dividend.
However, a major portion of its business comes from the U.S. government, so cuts in defense spending could limit the results of its operating segments. It has factored sequestration in its 2013 sales guidance, which is expected to be at the low end of the prior range.
Going forward, growth in the Information Systems & Global Services and the Mission Systems & Training segments is critical as sequestration is expected to impact about $275 million in each of these segments with the remaining in the other business areas.
Given the pros and the cons, the stock is expected to perform in line with the broader market indices. Currently, Lockheed Martin has a Zacks Rank #3 (Hold).
However, we prefer peers like Erickson Air-Crane Incorporated (EAC) with a Zacks Rank #1 (Strong Buy), and Wesco Aircraft Holdings, Inc. (WAIR) and Northrop Grumman Corp. (NOC), both with a Zacks Rank #2 (Buy).
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