A few days ago, Jonathan Goldberg posted a bullish analysis of Lockheed Martin. He used his equity value per share model, combined with a 3% growth assumption, to come up with an intrinsic value of $108.50 per share. Since its current price of $74.95 is slightly below Mr. Goldberg's margin-of-safety entry point of $76, he concluded that it was undervalued.
This post is intended to be a complement to his own analysis.
Lockheed Martin is a well-known defense contractor, with about 93% of its revenues coming from the U.S. government. Its four segments are Electronic Systems, Information Systems and Global Services, Aeronautics, and Space Systems. The company has done rather well for itself over the last ten years, with the notable exception of 2000 and 2001. 10-year return on equity, as calculated by dividing a 10-year sum of net incomes by a 10-year sum of shareholders' equities, is 18.26% for 1999 t0 2008. Growth in continuing-operations earnings per share, as calculated by a brute-force method using 2008 and 1999's EPSs, was 15.26% over the same timeframe. Long term, the company's grown a fair bit.
Its presence in the Low P/E Bin could be explained by a combination of the recent bear market, creating fears that Lockheed's earnings will implode, and a new Democratic Administration that might cut back on defense expenditures. The first risk factor has not shown up in Lockheed's earnings, and the second has not made itself evident yet. There's only been a bit of an earnings slump relatively recently.
Nevertheless, Lockheed's performance in 2000 and '01 was disappointing. Continuing-operations EPS were -$1.05 and $0.18 respectively. Another major defense company, General Dynamics, suffered no such blow to its own earnings in that time. General Dynamics is no longer in the Bin, but recently it was.
A glance at Lockheed's 10Ks for the period show why the company got itself into the trouble that it did. A large part of the losses were the result of an abortive attempt to get into global telecommunications. It could have been caused by tech-bubble mania back then. No similar effort has been launched by the company as of now; as noted above, almost all of its revenue comes from the U.S. government. Given the company's standing as a defense contractor, that 93% is indicative of Lockheed management sticking to the company's knitting. They venturing beyond that confine didn't work out too well last time. As of 2000, only 70% of Lockheed's sales were made to the U.S. government. A year later, it had wound down its global-communications segment. It seems that Lockheed's earlier troubles taught it a lesson, subsequently learned.
Its latest earnings have seen somewhat of a slump. As of June 30th, according to its latest 10-Q, 2Q '09 diluted EPS were $1.88 as compared with 2Q '08's $2.15. Diluted EPS for the first half of '09 were $3.55 as compared with $3.90 in '08. In 2008, the last year of EPS growth, all quarterly EPSs were above the EPSs of the same quarters a year ago.
The order backlog is also rising, which ostensibly is good news. The backlog was virtually steady from 2001 to 2007, though: those years saw EPS growth much higher than the 10-year results. The last jack-up of the backlog was in 2003, and the following year saw EPS growth of 20.9%. On the other hand, the backlog grew smartly in 2000 and 2001. Both years were real disappointments for Lockheed. I don't believe that next year will be a repeat of 2001 because Lockheed has not moved beyond its core business this time 'round. I include this discussion to point out that a rising backlog isn't always as good as it seems.
Disappearance in EPS growth explains why Lockheed's in the Bin. Also, the company's growth over the last eight years came in large part from the wars the U.S has been in. Anyone buying this company as a growth engine at a discount is assuming that there will be similar compelling reasons for the U.S government to buy Lockheed's higher-margin products. It's an assumption that has good odds behind it, as post-WWII U.S. history shows, but it may not hold up during this Administration. The trouble with Lockheed is that its 3.04% dividend yield isn't that great, so there's not much pay for waiting. It has increased its dividend every year in the last six, but that growth took place in tandem with EPS growth. That growth can't be expected in the near future, even though its dividend is solidly covered.
Should this Administration and Congress turn out to be dovish, then Lockheed's earnings won't do all that much. However, there's nothing on the horizon to suggest future disaster will afflict the company. It may prove to be a churner, but there's no sign it's a disaster in the making.
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