Lockheed Martin Corp (LMT US)

Faisal M. Hamawi

Undergraduate Top-Down Stock Analysis

August 5th, 2016

Global

Lockheed Martin Corporation is a global security company that primarily researches,

designs, develops, manufactures, and integrates advanced technology products and services.

The Company businesses span space, telecommunications, electronics, information and

services, aeronautics, energy, and systems integration. Lockheed Martin operates worldwide.

Being an American business with a focus on the aerospace and defense fields Lockheed

is subject to global constraints such as commodity prices, and political and economic conditions.

Such conditions directly impact the company and the industry of industrials. Also businesses in

these industries are highly specialized so market saturation is low, being the high capital

demand and government regulation and security associated.

As a manufacturer of defense systems, missile and fire controls, and military

aeronautics, an important measure of the industry's success is the global risk index. I've

examined the progression of country risk from the period of September 30th 2011 to June 30th

2016. Whereas GDP year-over-year grew at an average of 3.4% annually, so did the

government budgets, defense spending, and international conflicts.

A recent report stated “Global armed conflicts becoming more deadly, major study finds”

(The Guardian, IISS ACS) where in 2010 there were 55 active conflicts with fatalities amounting

to 49,000, while in 2014 42 conflicts took place with 180,000 fatalities reported. As an effort,

global powers push to increase military spending, expanding their budgets to combat threats of

such dire nature.

U.S.

Being that the United States government is Lockheed Martin’s largest customer, fiscal

and monetary actions implemented by congress or the president will ultimately affect the firm,

especial regarding the defense budget. In 2011 The Budget Control Act, which called for a

reduction in defense spending of $487 billion over a ten year period, and an additional $500

billion in 2013 over a nine year period through sequestration. However, the impacts of the cuts

are ambiguous, since government agencies may choose to allocate their spending in whichever

way they see fit. (10-K, Pg. 30)

However no western countries, those allied with the United States, and those exposed to

military conflict have increased their spending in the industries revolving around Global Military

Aircrafts and Aerospace Manufacturing, as well as Missile and Fire control, and Mission

Systems and Training. IBISWorld reported an annual increase in defense spending at 2.7% at a

total of $862.4 Billion over the five years working up to 2016, such countries in developing

economies and those in Middle Eastern and Asian countries demonstrated the most growth.

The increased demand by non-NATO countries is expected to increase American

industry revenues at an annual rate of 6.9% to $241.2 billion, this growth will offset the decline

in in Military spending domestically and recover profitability.

Industry:

Demand for military aircrafts domestically had witnessed a dramatic decline in

demand as the United States fought to reduce the fiscal deficit by cutting defense

spending. In 2011 The Budget Control Act, which called for a reduction in defense

spending of $487 billion over a ten year period, and an additional $500 billion in 2013

over a nine year period through sequestration will significantly reduce LMT’s future cash

flows. As growth slowed down in recent years, long-term top priority contracts such as

those for the F-35 stealth fighter were generally unaffected.

Conversely, international demand boomed as emerging markets continued to

grow, and geopolitical tensions continued to worsen. Non-NATO countries experienced

growth in their defense budgets at an annual rate of 2.7% in the five years to 2016.

Countries such as South Korea, Israel, and Saudi Arabia have realized the most growth.

Lockheed Martin is classified in the Standard and poor's under the Industrials

Segment of the market which is identified as S5INDU (Orange) in the rotation graph

below. We can see from the general movement of the industry that it is moving out of

the weakening state and slowly improving and potentially leading; this can be attributed

to the increased international demand that brings foreign direct investments into the

market.

Since the industry is exposed to transaction

risk, and since their products rely on certain rare

earth metals and commodities that are very volatile

in price and demand, Lockheed must leverage their

commodities with long term contracts. As of

December 2015, Lockheed purchased

commodities on the forward markets through long-term contracts, and through

maintained inventory levels did they achieve a degree of flexibility that may adjust for

fluctuations in prices. Relative prices for commodities were not stated in the annual

report, but can be accessed through the Bloomberg terminal below.

Lockheed Martin:

Financial Analysis:

On the key adjusted data we see that Lockheed Martin significantly increased their

Market Capitalization through a significant increase in Debt. We can also see steady growth in

revenues and greater growth in net income; gross Profits and Earnings Per Share also had

double digit rate increases in their values.

The increases in Liabilities can be attributed to increases in Inventories and current

assets, most of which were financed through Payable and Long-term debt. Though these spikes

may appear alarming at first, further investigations will show these increases are due to

long-term contracted projects with multiple large entities placing big ticket orders of their popular

products. “Sales to foreign military customers rose 10% in 2015, while those in the U.S. fell

2.4%.” (BI Primer), some contacts are as recent as June, “Lockheed Martin Wins $3 Billion

Fighter Jet Order From Denmark” (Bloomberg, Levring 06/09) and some older contacts from

2015 “U.S. Approves $11 Billion Saudi Buy of Lockheed Littoral Ships” (Bloomberg, Capaccio

and McMahon 10/20). And the orders keep on coming.

With the acquisition of Sikorsky Aircraft Systems, Lockheed may expand their Business

operations which may further expand their international sales growth; this can be seen in some

increases in the company's ROIC and ROA, along with some decline in Operating Margins to

come. However, overall outlook is positive and stable relative to their growth and profitability.

Now, most of their revenues can be attributed to their Aeronautics segment of their

operations leading at 33%, but the segment also contributes a share of 44% of their segments

capital expenditure, an increase from previous years. However, Lockheed aims to be more cost

effective, if they hope to maintain their advantage over their competition.

Earnings and Valuation:

Current Trailing Price to Earning is 21.54, the 12 month forward P/E is expected to

decline to 20.82, this can be attributed to earnings growth in the future; this assumption is valid

due to the estimated Long-term growth rate of 7.16%. The LMT US Equity stock is currently

traded at a price of $256.85 a share; analysts expect the target price to reach $262.18, which is

a fair rate of growth considering the volatile nature of the industry.

Bloomberg Intelligence review states that Lockheed market, operational, and financial

activities are in line, if not excelling in their decisions. In fact, most credit agencies have rated

Lockheed as a stable outlook company with a fair credit rating.

The Firm's 1-years default probability is 0.0225%, relatively low considering the default

rate had been declining since January 2016. Price volatility is at a 16.26% and declining, which

may prove to be a secure stock to hold for the long-run. However their Debt to Equity is greater

than industry average.

When examining Lockheed's relative value to other competitors in the industry, we find

their P/E slightly higher than their domestic competition, their Return on Equity is 123.41% a

rate significantly greater than the average and any other competitor. Lockheed does however;

provide a nice Dividend yield of 2.51%

Lockheed's Sales growth is greater than any of their competitors, at a 7.92% annual

growth rate, EPS growth rate (2.34%) is lagging, and Revenue growth is very low compared to

others, but that can be expected from a company with such high capital expenditures. The

Industry slope is slightly positive showing steady long run growth.

Lockheed Martin has exceeded earnings expectations almost every quarter historically,

and analyst estimates were in line most of the time.

Cost of Capital:

Lockheed's long-term debt is 16.4% of their market capitalization, and at a cost of 1.5%

which relatively low, however their cost of equity is high (7.5%) which weighs 83.1% bringing

their weighted average cost of capital to a 6.5% much lower than the industries 8.22%. As of

now, their return on invested capital (ROIC) is greater than their WACC, and has been that way

for a while except in the 2015; the dip in 2015 is due to their acquisition of Sikorsky, the Vertical

aircraft company, which is actually proving to be lucrative in its fundamentals.

Their adjusted beta is 0.788 with an R^2 of 0.377, a relatively large spread. Their alpha

is 0.341 signifying a positive outlook relative to the S&P 500.

Dividend Discount Model:

The company's dividend Yield is 2.49% with annual dividends of 6.762 per share, a nice

rate compared to competitors, Long term Growth rate is estimated at 7.160% bringing their

theoretical price to $245.607 per share. However if the LT Growth rate was at 7.8% we would

find their theoretical and current price to be equal. But as of now the stock is overvalued.

Lockheed has 227 suppliers for their various segments and 11 major customers,

(excluding Foreign entities with big ticket transactions) of their customers, the United States of

America is their biggest customer contributing 78% of LMTs revenues. They have 25

competitors of those; Raytheon Integrated Defense Systems, Northrop Grumman, and Boeing

Military Aircrafts are the largest.

Below, I’ve overlaid the Standard and Poor's 500 indexes over LMT US equity stock, and

from the two year graphic depiction, it is obvious, Lockheed enjoys fewer fluctuations in their

stock price compared to the S&P and their competition.

Price Valuation:

Below we see Lockheed's stock price as a function to different values for Earnings per

Share (EPS), and Price Earnings estimates. Graphically, we see a dramatic climb in LMTs stock

price regardless of growth estimates and expectations, this can be attributed to the fundamental

growth they have been realizing from their activities regarding sales, marketing and

management.

Discounted Cash Flow Analysis:

Horizon values for revenues and Free Cash Flows continue to grow at single digit rates,

while EBITDA is expecting margin growth in the double digits annually, so the EBITDA Multiple

methods estimated value per share is $258.49 a 1% upside from the current price of 256.85

meaning it is almost fairly valued. The Perpetuity Growth model estimates the value to reach

$417.93 per share an 63% upside (unless this method is estimating the value in 7.7 years, the

value may be questionable).

Conclusion:

Lockheed Martin Corporation will continue to face strong demand, as global tensions

worsen and as economies grow. The potential upside to owning stock in Lockheed is great, and

as technologies become more advanced, reducing costs and increasing efficiency, Lockheed

Martin could one day reach the moon with its potential.

“(Lockheed Martin) won a $3.9 billion NASA contract to build a spacecraft that will return

U.S. astronauts to the moon, beating a Northrop Grumman Corp.-led team.” (Bloomberg,

Lococo, Mclean)

Bibliography:

Ferguson, George & Rothchild, Douglas, “F-35, Sikorsky Key Drivers of Lockheed's Revenue

Growth”, (Bloomberg Intelligence ) Bloomberg Terminal, Published 07/22/2016

Ferguson, George & Rothschild, Douglas, “Election, Islamic State Spur Defense Spending:

Midyear Outlook” (Bloomberg Intelligence ) Bloomberg Terminal, Published 06/14/2016

Norton-Taylor, Richard “Global armed conflicts becoming more deadly, Major study finds” The

Guardian . Web. Published 05/20/2015

https://www.theguardian.com/world/2015/may/20/armed-conflict-deaths-increase-syr

ia-iraq-afghanistan-yemen.

Levring, Peter, “Lockheed Martin Wins $3 Billion Fighter Jet Order From Denmark”

Bloomberg.com , Web. 06/09/2016

http://www.bloomberg.com/news/articles/2016-06-09/lockheed-martin-wins-3-billion

-fighter-jet-order-from-denmark

Soshkin, Maksim, “Global Military Aircraft & Aerospace Manufacturing” IBISWorld Industry

Report C2544-GL. IBISWorld.com. Web. April 2016

Capaccio, Anthony & McMahon, Madeline “U.S. Approves $11 Billion Saudi Buy of Lockheed

Littoral Ships” Bloomberg.com , Web. 10/19/2015

http://www.bloomberg.com/news/articles/2015-10-20/u-s-said-to-approve-saudis-buyi

ng-11-billion-in-littoral-ships

“Lockheed Martin Corp. Annual Report (Form 10-K)” Security and Exchange Commission

(SEC), PDF. 12/31/2015

https://www.sec.gov/Archives/edgar/data/936468/000119312513082873/d428940d10

k.htm