Lockheed Martin: Problems keep piling up (NYSE: LMT) | Private Equity Weekly

Lockheed Martin Corporation (NYSE:LMT) is a popular investment among dividend investors and is considered a long-term safe haven.

Shares of the F-35 maker have largely stagnated since a geopolitically driven rally in late February 2022 as investors Waiting for higher defense budgets to translate into profits.

That’s proving more difficult than expected, as supply chain issues, constraints on pricing capabilities and ongoing macro uncertainty have investors questioning Lockheed’s ability to accelerate growth.

Let’s take a closer look.

About Lockheed Martin

Who doesn’t know Lockheed Martin? The company has been one of the U.S. government’s largest contractors for decades as it plays a vital role in protecting the United States and its allies.

I have been covering the company on Seeking Alpha since early March 2023.At first, I was The company is Strong Buy, check out its growth and profits The problem is temporary. After a few months, I started to realize that the supply chain issues were still there, or even worse, The question of profitability is There’s more to the structure than I initially thought, which led me to downgrade the stock to Hold.

I think the image below paints a clear story:

After initially rising following Russia’s invasion of Ukraine, the stock began to fall as the company failed to resolve its supply chain issues. Management then inspired optimism, pointed to improvements and delivered better-than-expected results.

Then came the earnings announcement in July 2023, when management basically said that higher demand wouldn’t lead to better profitability and that it would be a multi-year revenue story rather than accelerating near-term growth.

The stock continues to lag the market and peers as market appetite shifts toward higher risk and investors price in Lockheed’s medium-term outlook.

If that wasn’t enough, the latest blow came last week.

Biden plans to cut F-35 orders by 18%

Post-pandemic, spending by governments around the world is under scrutiny amid uncertainty about inflation and high interest rates.

However, as geopolitical tensions rise and investors discount the government’s willingness to cut defense budgets, most market participants, myself included, expect defense spending to continue growing in the near term.

Reuters reported that the United States President Joe Biden Asking the Pentagon to reduce the number of jets it buys by 2025 by 18%, arguing this is an area where he can relieve pressure on Congress.

That would be a major blow for a company that is currently aggressively expanding its production capacity and derives about 40% of its sales and profits from its aerospace division, which mainly consists of F-35 aircraft.

stagnation persists

Even before the recent news broke, Lockheed was already at a standstill. In 2023, the company’s revenue will be US$67.6 billion, an increase of only 3% from 2020, and has remained in the range of US$65-67 billion for the past four years.

Rather than improving, margins fell slightly, resulting in consolidated operating profit of $8.5 billion, below 2020 levels.

As we can see, stagnation is widespread across all market segments, with the space industry being the only outlier. Still, even the fastest-growing segment is only 6% above 2020 levels.

Additionally, the only segment to experience margin improvement from 2020 to date is RMS, which expanded 138 basis points. The rest is basically flat.

By now, you might have expected Lockheed to solve at least one of these problems, whether it’s growth or profitability, but that’s not the case. There are no signs of improvement heading into 2024 either.

Looking at management’s guidance for 2024, we can see that the only segment expected to see meaningful growth is MFC, while the remaining segments are set for another flat year. Furthermore, profit margins are expected to remain broadly unchanged again.

Balance sheet and capital returns deteriorate

As Lockheed’s woes continue, the soon-to-be Dividend Aristocrat has become increasingly reliant on outside capital to provide cash returns to its shareholders.

Over the past two years, Lockheed’s cash payout ratios have been 178% and 145%, respectively, which are the two highest figures in the past decade, except for a jump in 2018. A payout ratio above 1 means the company is using either dilution or debt to fund buybacks and dividends, a feat that’s not necessarily good for shareholders in today’s interest environment.

Therefore, we can see that net debt is increasing while EBITDA is flat, resulting in an increasingly higher net debt/EBITDA ratio. Additionally, the company’s net interest expense continues to increase and will reach 1.4% of revenue in 2023, compared with the historical average of 1%. This makes sense for companies with margins below 10%.

Valuation

So far, I think the Lockheed Martin we’ve built is the definition of steadfastness. Slow or no growth, and virtually no potential for significant profit expansion. In a best-case scenario, Lockheed’s operating margins are around 14%, as the company’s profitability is limited by: Increase in costs Nature of business.

Historically, LMT’s P/E range has been 16x to 18x. Now, with the company expecting earnings per share to decline in 2024, bad news piling up, and no clear signs of improvement in the near term, I think it’s very reasonable for the company to trade at the lower end of that range.

In other words, I think Lockheed Martin is fairly valued. There are two problems with doing a fair valuation in today’s market. First, investors are generally in risk-taking mode, looking for fast-growing companies to beat the market rather than stalwart companies to protect their downside risks. Second, there are many growers who are making quick profits.

As many unprofitable and non-self-sufficient companies will learn in 2022, the market is far more tolerant of inefficiencies. This has resulted in many companies experiencing major operational changes and large-scale layoffs. We’re seeing many companies achieve margin expansion and top-line growth.

So the only real way for Lockheed to beat the market is if the market goes down. For some investors, especially those looking for steady dividend income, this is enough to justify their stance.

in conclusion

Lockheed Martin is a cornerstone of U.S. defense capabilities and should continue to be so for the foreseeable future.

The company that plays a key role in producing the world’s most advanced fighter jets has struggled to revive revenue growth despite rising geopolitical tensions and growing demand.

In a business based on a cost-plus arrangement, a story of profit expansion does not produce bottom-line growth.

As the headwinds continue to mount, coupled with recent news that F-35 orders are expected to decrease by 18%, I see no path to improvement in the short term.

Therefore, I expect Lockheed Martin to continue trading at the lower end of its valuation range and rate the stock a Hold.