Skip to main content
  • Geopolitical uncertainty supports increasing military budgets.
  • Lockheed Martin's dividend is attractive, and it could potentially grow.
  • Shares have retreated toward support levels, suggesting they may soon find footing.

Russia’s invasion of Ukraine earlier this year reinforced risks associated with geopolitical uncertainty, increasing the likelihood of growing global defense spending.

Military spending was already somewhat inelastic. After all, global economic unrest can increase, rather than decrease, instability. As a result, countries may trim military budgets on the edges or delay spending in a pinch, but in the U.S., significant and lasting wholesale cuts to military budgets have been avoided.

It’s for this reason that U.S. military spending has marched higher over time. The U.S. spent $83 billion on Defense in 1970, $144 billion in 1980, and $325 billion in 1990. In 2020, spending totaled $778 billion, above the $736 billion you’d expect when you adjust 1990’s spending for inflation.

This historically steady-eddy spending underpins defense contractors, including Lockheed Martin  (LMT) , making it an intriguing stock to include in portfolios, particularly given defense spending among European allies is heading higher because of War in Ukraine.

In “Here's Why We're Going Defensive,” Action Alerts PLUS co-Portfolio Managers Bob Lang and Chris Versace explain why they added Lockheed to AAP’s portfolio this past week.

They write:

“In the current environment characterized by geopolitical conflict and tensions, we are likely to see continued increases in defense spending. This week alone, U.S. Senate Democrats included another $12.3 billion in economic and military aid for Ukraine in a must-pass government funding bill, which includes $1.5 billion to replenish U.S. military stockpiles. Some of the weapons that the U.S. has delivered so far have included long-range rocket launchers known as Himars, which were critical in Ukraine's retaking of more than 3,500 square miles from Russia and are Lockheed products.”

It’s not just the U.S. that’s spending more because of Ukraine. Germany’s responded to Russia’s War with a 100 billion Euro special fund this year designed to upgrade and expand its capabilities. In 2021, it spent just 47 billion Euros on defense. France is spending about 41 billion Euros on Defense in 2022. This week, it announced a budget that will increase that amount by 7.4% in 2023, bringing its spending to 36% higher than in 2017.

At least some of the increased spending in Europe could be heading to Lockheed Martin. For instance, despite stiff competition from European rivals, six nations (Germany, Belgium, Poland, Switzerland, Czech Republic, and Finland) plan to buy Lockheed’s F-35 fighters.

Back to Lang and Versace:

“Lockheed breaks its business down into four segments:

Aeronautics (40% of 2021 revenue) includes advanced military aircraft, including combat and air mobility aircraft, unmanned air vehicles, and related technologies. Aeronautics also has contracts with the U.S. Government for classified programs. Major programs for this business include:

*F-35 Lightning II Joint Strike Fighter - international multi-role, multi-variant, fifth-generation stealth fighter. This is the company's largest program, accounting for 27% of total company sales in 2021 and 68% of segment sales during the year.

*C-130 Hercules - international tactical airlifter;

*F-16 Fighting Falcon - low-cost, combat-proven, international multi-role fighter; and

*F-22 Raptor - air dominance and multi-role fifth generation stealth fighter.

Segment customers include the military services, principally the Air Force and Navy, and various other government agencies of the U.S. and other countries, as well as commercial and other customers. In 2021, U.S. government customers accounted for 65% and international customers accounted for 35% of Aeronautics' net sales.

Missiles & Fire Control (17% of 2021 revenue) focuses on air and missile defense systems; tactical missiles and air-to-ground precision strike weapon systems; logistics; fire control systems; mission operations support, readiness, engineering support, and integration services; manned and unmanned ground vehicles. Key customers include U.S. government and military services, principally the Army and international customers.

Rotary & Mission Systems (25% of 2021 revenue) - This business manufactures, services and supports various military and commercial helicopters, surface ships, sea, and land-based missile defense systems, radar systems, sea, and air-based mission and combat systems, command and control mission solutions, cyber solutions, and simulation and training solutions. U.S. Government customers, including the U.S. Navy and Army, accounted for 70% of revenue in 2021, international customers accounted for 28% and U.S. commercial and other customers accounted for 2%.

The Space segment (18% of 2021 revenue) focuses on satellites, space transportation systems, and strategic, advanced strike, and defensive systems. Customers include the Air Force, U.S. Space Force, Navy, National Aeronautics and Space Administration (NASA), Missile Defense Agency (MDA), and various government agencies of the U.S. and other countries along with commercial customers. In 2021, U.S. government customers accounted for 92% and international customers for the balance.”

There are other defense contractors that AAP considered. Still, Lockheed Martin was particularly attractive to Lang and Versace because of its dividend and relatively low exposure to private/commercial spending.

They write:

“We prefer the prospects for EPS growth as well as end market and dividend yield exposure offered by LMT shares compared to others. For example, while the shares of General Dynamics  (GD)  have smaller dividend yield to those with LMT shares near 2.3%, its Aerospace segment (20% of revenue) primarily serves the business jet market, one that could be challenged as the economy slows. Shares of Northrop Grumman  (NOC)  have a fraction of the forecasted EPS growth for Lockheed in 2023 and its dividend yield is 1.5%.”

That’s not to say that Lockheed Martin is immune to the negative impacts of inflation on profit margin or project delay headwinds to revenue. However, AAP believes those risks are manageable.

In July, the company cut its full-year revenue forecast to $65.25 billion from $66 billion because of problems with supply chains and delays. In the second quarter, revenue slipped 9% year over year. On the bottom line, EPS fell 2% year over year to $6.32 in Q2. Nevertheless, the company remains highly profitable, and because it kicks off plenty of cash flow, its dividend and buyback program could increase.

It currently pays $2.80 per share per quarter, giving a 2.9% dividend yield; and its dividend has increased every year since 2002, including during the Great Recession. In addition, as of June 30, $1.6 billion remains on its buyback program, providing additional support to shares.

Lockheed Martin’s valuation isn’t too concerning. Shares peaked near $480 after Russia invaded Ukraine, but they’ve retreated to $387. The consensus earnings outlook for next year has increased over the past 60 days to $27.95, so the company’s forward price-to-earnings ratio (P/E) is 13.8. Over the past five years, its five-year P/E range has been 12 to 26, so, assuming next year’s outlooks don’t get cut, shares aren’t too pricey.

It could be a good technical entry point, too. Shares are trading below the 200-day moving average; however, support exists at the July low of $374 and the October 2021 peak of $378.

In “Chart of the Day: This Fighter Jet Name Should Start Taking Off,” Lang and Versace write, “ While the more recent action is bearish, we see this as a great opportunity to add shares on the downside. Technically oversold here, we see the $370-$380 level as strong support, so adding a bit here today is a strategic move."

image (5)

The Smart Play

This isn’t a barn-burner, high-flyer stock, but that’s OK. During bear markets, you’re better off focusing on quality type stocks rather than high-volatility, unprofitable stocks. Lockheed Martin’s 0.66 beta means that its volatility is lower than the S&P 500 and because its’ dividend payout ratio is 64%, there’s arguably room for the C-Suite to reward shareholders with another dividend hike in the coming year. Of course, it doesn’t hurt that its balance sheet is solid. Its current ratio – a measure of its ability to cover short-term liabilities with short-term assets – is a healthy 1.27.

Ideally, management will clarify how quickly defense budget increases will flow through to its financials in the coming quarters. Also, when the company reports third-quarter results on Oct 26, it will be interesting to hear if there’s any improvement in the supply chain that can alleviate the bottlenecks behind the company’s lowered guidance this summer.

If you’re interested in adding Lockheed Martin to portfolios, consider following AAP’s lead by adding shares in multiple tranches rather than buying shares all at once. At 1.01%, Lockheed Martin is AAP’s smallest position, and since the portfolio’s average weighting is 2.65%, there’s plenty of room to buy more shares as opportunities present themselves.

Tags
terms:
THUMB-Stock-Market-JS-120622

A Make-It or Break-It Moment For Stocks

The S&P 500 is at a critical crossroads that could determine if the next move for stocks is a pop or a drop.

THUMB-Stocks-JS-120522

One Pricey Stock To Sell, And One Cheap Stock to Buy

Valuation relative to historical levels can help investors know if it’s time to buy or sell stocks because they’re too expensive or cheap.

Chart_Static_KL_120222

This Week’s Economic Data Didn’t Change Much

The Fed's path remains unlikely to change because of this week's news, offering investors little additional conviction.

A Make-It or Break-It Moment For Stocks

A Make-It or Break-It Moment For Stocks

The S&P 500 is at a critical crossroads that could determine if the next move for stocks is a pop or a drop.

THUMB-Stocks-JS-120522

One Pricey Stock To Sell, And One Cheap Stock to Buy

Valuation relative to historical levels can help investors know if it’s time to buy or sell stocks because they’re too expensive or cheap.

Chart_Static_KL_120222

This Week’s Economic Data Didn’t Change Much

The Fed's path remains unlikely to change because of this week's news, offering investors little additional conviction.

nyse_trader_kl_091522

Why Trusting This Stock Market Rally Is Tough

There's good reason to wonder if the recent rally in stocks is about to stall.