Lockheed Martin

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 4/5

Lockheed Martin is a global aerospace, defense, security, and advanced technologies company, heavily reliant on US Government contracts. It engages in research, design, development, manufacture, integration, and sustainment of advanced technology systems, products, and services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Lockheed Martin (LMT) operates primarily in the aerospace and defense sector, with a strong emphasis on serving the U.S. Government. Its business is segmented into four main areas:

  • Aeronautics: This segment focuses on the design, development, and manufacturing of advanced military aircraft, such as the F-35 Joint Strike Fighter, the F-16 Fighting Falcon, and the C-130 Hercules. This segment is characterized by long-term contracts and significant government funding.
  • Missiles and Fire Control (MFC): The MFC segment specializes in missile systems, air and missile defense systems, fire control systems, and other related weapons. This is a major segment of the company with continued focus on R&D.
  • Rotary and Mission Systems (RMS): RMS is involved in the design, manufacture, service, and support of various military and commercial helicopters, surface ships, and combat systems. It also produces logistics, electronic warfare, and cyber systems, training simulators, and other associated equipment and services.
  • Space: This division focuses on the engineering, development, production, and support of satellites, space exploration vehicles, and other space technologies. It also provides services for customers including satellite launches and data analytics.

Revenue Distribution LMT’s revenue is heavily dependent on U.S. Government contracts, especially the Department of Defense (DoD). 82% of its 2022 net sales were from the U.S Government. The rest come from International customers. A significant part of its revenue is tied to large-scale, long-term programs that span several years. While international sales account for only a minority of revenues, LMT is seeking to make it a larger share of their total revenues. It was mentioned that approximately 53.8% of the backlog was attributable to U.S. Government contracts.

Competitive Landscape

LMT faces a unique competitive landscape. It competes with other major aerospace and defense contractors such as Boeing, Northrop Grumman, Raytheon, and General Dynamics. These competitors have similar relationships with the government. However, LMT differs due to its dominance in specific, advanced, and highly critical defense programs like the F-35 Joint Strike Fighter, giving them a unique niche that competitors are unable to immediately supplant. LMT also has an extremely diversified portfolio and provides more than one segment.

Recent Trends in the Industry The defense industry is currently benefiting from increased geopolitical tensions that have increased governments defense budgets. In addition, the war in Ukraine has accelerated demand for advanced defense and weapon technology. Countries such as Poland are scrambling to buy equipment.

What Makes Lockheed Martin Different

LMT’s differentiation lies in its technological prowess, long-standing relationships with governmental agencies, and its massive scale in core defense programs. Few companies can match the depth and breadth of LMT’s capabilities across the aerospace and defense spectrum. The company’s specialization in advanced and cutting edge technologies also helps keep competitors at bay. And it is not easy to compete with them as most of their revenue comes from large, long term contracts with U.S and allied governments, making it extremely safe and predictable. The company also has partnerships and is constantly looking to integrate with technology companies. It is heavily involved in AI and robotics and other advanced technologies to keep it’s competitive edge. It is also looking at expanding into the space domain.

Financials in-depth

LMT’s financial performance is characterized by substantial, predictable revenues and profits, largely driven by its long-term contracts with the U.S. government. However, these financials are also often affected by the stage of major programs, fluctuating expenses, and the timing of government funding. It is worth noting that the company had a major positive free cash flow in 2021 and 2022, even though its margins are small and its revenue growth has been weak in recent years. The management is focusing on increasing their return on invested capital (ROIC) by cutting costs and improving productivity across all segments. The management has also said that they want to keep using share repurchases to return capital to shareholders and to reduce share dilution from employee compensation.

  • Profitability: LMT maintains solid gross margins, but its operating margins are relatively modest due to high operating costs, especially for research and development. In the defense industry it’s very difficult for management to have a huge impact on margins, the industry is highly competitive on price, and most contracts are highly regimented with little to no wiggle room for the company to charge higher. This is also why the company relies on cost-cutting initiatives to increase profitability.
  • Return on Capital: LMT generates solid return on capital despite its large capital base. It is very important to compare ROIC with WACC as it shows what the company earns on their investments versus what investors are demanding.
  • Revenue Growth: Despite being heavily exposed to the defense industry, its revenue growth has been tepid due to various reasons. They have low organic growth and are trying to acquire growth through acquisitions. This is a trend that’s happening across their industry.
  • Cash Flow: Lockheed Martin has strong free cash flow due to its large, recurring contracts with the government. As mentioned earlier, the company also gives back excess cash through share repurchases. This is good for the shareholders.

Balance Sheet Health: 4/5

LMT’s balance sheet shows that it is a well-capitalized company, but that may be a concern to some investors. The company currently has a 51% debt to capitalization ratio and is trying to decrease it to the 15% it wants in the long-run. One thing that they are doing is using more equity and less debt to finance acquisitions in the future. They have significant debt, but their revenues from the government are considered quite predictable. Their credit rating with Standard and Poor’s is rated as a BBB+, which means that they are low risk for a business with this much debt. Their cash levels are good and are sufficient to run their operations. Their cash-to-debt ratio was quite low, about 0.2 at the last reporting period. However, their debt repayment and payment schedule is reasonable with some of the debt having extended maturities.

Moat: 3/5

LMT possesses a narrow moat that stems primarily from Intangible assets and switching costs:

  • Intangible Assets (Patents and Technologies): LMT has a significant portfolio of patents related to its various technologies. The most important one is probably their intellectual property portfolio for the F-35. This gives the company a competitive edge. However, because it is mostly military applications the IP may not be as applicable to other areas. LMT relies more on having in-house expertise as well as government approvals and contracts.
  • Switching Costs: The high complexity of defense contracts, high levels of government scrutiny, and their dependence on the LMT for crucial parts and services often results in high switching costs.

The company’s narrow moat is relatively durable, but it can erode under certain conditions. For example, if a competitor develops a superior military technology that renders LMT products obsolete, their economic advantage might be diminished. Also, if the government decides to diversify their contracts and decrease dependence on major players the economic advantage for LMT can lessen. It should also be noted, that their margins are quite low, as they don’t have much pricing power due to the nature of the contracts. The fact that they get a large amount of their business from the U.S government and that their financials are highly regulated, is both a benefit and a hindrance. While their revenues are safe and predictable, they are also tied to decisions that might not always be good for the company.

Understandability: 4/5

Lockheed Martin’s business is relatively easy to understand in terms of its operations as long as you know what they do, but the intricacies of how it is valued and its financials are complex. Here’s why: * The company’s segments are straightforward, focusing on recognizable areas like Aeronautics, Missiles, and Space. However it requires a deep dive into their financials to find what is creating value. * The business depends greatly on government spending and is heavily reliant on long-term contracts, making forecasting future earnings somewhat predictable, but also complex due to the nature of these long term contracts.

  • The use of acronyms and technical language in financial reports and earnings calls, though very much a problem everywhere, often make it confusing for new investors.
  • The company’s debt profile is readily available for analysis, but the leverage ratio is high compared to their industry counterparts. It is also difficult to discern how acquisitions affect their financials, though management has pledged to be more transparent going forward.

Legitimate risks to the moat and business resilience:

  1. Government Spending Cuts: LMT relies primarily on government spending, which is subject to political changes, budget cuts, and shifts in geopolitical priorities.
  2. Program Cancellations: Major development programs may face cancellations or delays due to cost overruns or program-performance problems.
  3. Technological Obsolescence: Rapid technological advancements in cybersecurity and defense could render current technologies obsolete. They have to constantly stay on the cutting edge to remain competitive.
  4. Supply Chain Issues: LMT’s supply chain may be disrupted, especially with geopolitical tensions and reliance on certain foreign manufacturers, and they would need to establish new suppliers.
  5. Competition: While LMT is a major player, it is not immune to competitor growth, especially from companies working on niche technologies.
  6. Inflation and rising costs will greatly impact the company’s ability to make profit in their long term contracts. Especially for multi-year projects where the pricing is already finalized.
  7. Workforce and Talent. The defense industry is facing a workforce crisis with declining interest in the industry, as well as a shift away from traditional forms of operation. The company would have to adapt to make sure that they have the correct workforce for their goals.

Controversies and Problems:

  • F-35 Program Issues: There have been numerous reports about problems and cost overruns on the F-35 program. Even though the F-35 is the most valuable defense project in the world, the program has faced difficulties with testing, maintenance, and logistics. It also faces increasing competition from other programs and countries such as South Korea.
  • Acquisition Integration: The integration of new companies that they have acquired in the past may be costly and may impact profitability if not managed correctly. Their recent push to acquire more companies may also prove to be a negative if integration does not go smoothly.
  • Tax issues: The company faced scrutiny in 2019 for using a tax loophole that saved them a lot of money. This has led to calls to tax laws to be more efficient and might lead to a higher tax burden for LMT. It also means that future tax savings from debt may be limited.

Management’s response:

  • The management has made it clear that the F-35 program is important and that they are working on resolving the problems around it. This will likely continue to be the flagship program of the company for years.
  • They are focusing on integrating the new technologies and companies they acquire and aim for a more synergistic approach to growth.
  • The management has reiterated that they are always in compliance with applicable tax laws and regulations, and are confident in their abilities to make good decisions for long term growth.