Lockheed Martin (LMT) is the world’s largest pure play aerospace & defense company based on revenue. The stock is also a dividend growth stock with a decent yield of over 3% at the moment. Lockheed Martin has raised the dividend for 18 consecutive years making the stocks a Dividend Contender. As a defense contractor, Lockheed Martin has a wide moat. Few other companies can make its essentially custom products. It would require a skilled technical workforce that few other companies can replicate in scale. Furthermore, many of Lockheed’s main programs are large and have decades long life cycles requiring modernization and sustainment. For example, the F-16 was first produced decades ago in the mid-1970s. This leads to growing revenue and earnings over time. In turn, this translates to a rising dividend. I view Lockheed Martin as a long-term buy.
Overview of Lockheed Martin
Lockheed Martin Corporation is the world’s largest defense company. The company was founded in 1912. About 60% of the company’s revenues comes from the U.S. Department of Defense, with other U.S. government agencies contributing about 10%, and international clients making up the remaining 30%. The company consists of four business segments: Aeronautics (~40% sales) - which produces military aircraft like the F-35, F-22, F-16, P-3 Orion, and C-130; Rotary and Mission Systems (~26% sales) - which houses combat ships, naval electronics and helicopters; Missiles and Fire Control (~16% sales) - which creates missile defense systems; and Space Systems (~17% sales) - which produces satellites. The company has significant strength and exposure in military aircraft. The company had total revenue of over $59.8B in 2019.
Lockheed Martin’s Revenue and Earnings Growth
Lockheed Martin’s revenue and earnings have grown over the past decade. There have been short-term declines, but these are often temporary. In defense contracting programs are often completed without an immediate replacement. Changes to defense budgets as administrations change can also impact programs and revenues, which is a risk. Defense programs have been cut in the past and Lockheed Martin has been affected. For instance, the F-22 production was ended early due to high costs and other contributing factors.
Today, Lockheed Martin’s top line is growing due to the strength of the F-35, F-16 upgrades, missiles, and space. Lockheed Martin’s products are in demand in the U.S. and in allied nations. The F-35 is arguably one of the most advanced military aircraft in production. It is being fielded by the U.S. but also by many of its allies and there is significant demand. The U.S. Department of Defense plans to buy 2,456 F-35s for the Air Force, Navy, and Marines through 2044.
The total count is even higher as many allied nations are also purchasing export versions of the aircraft. With a flyaway cost of about $80+ million depending on the variant and the possibility of modernization and sustainment revenue, the stealth fighter will drive revenue and sales growth for many years to come. Lockheed Martin is also growing by periodic acquisitions as part of the general trend of industry consolidation.
As the world’s largest aerospace & defense contractor Lockheed Martin is a in good position to make acquisitions. The company bought Sikorsky from United Technologies (UTX) in 2015. Sikorsky is now a major contributor to revenue has a large base of helicopters that require upgrades and sustainment. The Sikorsky acquisition also had the effect of reducing competition for future programs.
Currently, Lockheed Martin is trying to acquire Aerojet Rocketdyne (AJRD) for $4.4 billion. This acquisition would add to the company’s strengths in hypersonics and space. If you examine the chart above, it is apparent that Lockheed Martin’s margins have been rising over the past decade.
Gross margins are rising, which indicates that the cost of sales as a percentage of total sales are declining. Gross margins are about 50% higher than 10-years ago. Operating margins are also rising, which indicates that operating costs are not increasing as fast as operating income. Operating margins are nearly double that of 10-years ago.
Lockheed Martin Dividend Growth and Safety
Lockheed Martin’s divided has grown at nearly 10% annually over the past 5-years and 14% annually over the past decade. Recently, dividend growth has been slowing, but the rate is still high. This is impressive for a mature company with nearly $60 billion in revenue and $100 billion market capitalization. Lockheed Martin’s forward payout ratio is approximately 42% leaving room for further dividend increases.
Source: Source: Portfolio Insight
I like the fact that from the perspective of earnings, free cash flow, and debt Lockheed Martin’s dividend safety is conservative. The current forward dividend is $10.40 per share giving a yield of about 3.1%. The payout ratio is about 42% based on consensus earnings of $24.50 per share in 2020. This is a very good value and below my threshold of 65%. Hence, I am reasonably assured that earnings will cover the dividend even during recessions.
The dividend is also safe on a cash flow basis. Operating cash flow in the TTM was $7,866 million. Capital expenditures were $1,687 million giving free cash flow of $6,179 million. The dividend required $2,711 million giving a dividend-to-FCF ratio of roughly 44%. This is another very good value and below my criterion of 70%. It means the company generates sufficient cash to pay the dividend even during an economic downturn.
The balance sheet is also reasonably conservative, and the company has an A- corporate credit rating. At end of Q3 2020, Lockheed Martin had $3,585 million in cash and cash equivalents on hand offsetting $1,000 million in current long-term debt and $11,675 million in long-term debt. Interest coverage was about 15X at end of the quarter. The leverage ratio was 0.9X. Lockheed Martin can pay its obligations. Furthermore, debt or leverage is not excessive and thus does not place the dividend at risk.
Lockheed Martin’s Valuation
Aerospace & defense stocks were pressured in 2020. In fact, the industry was down about -14% last year. Lockheed Martin declined -6.5%. The stock did poorly relative to the broader market and S&P 500, which had a double-digit gain of approximately 18.3%. Lockheed Martin is currently undervalued based on earnings multiple. In the past 5-years the average price-to-earnings ratio was nearly 19X. The stock is currently trading at about 13.7X. If we assume a fair value multiple of 16X this gives a fair value estimate of $392.
A second valuation model, the Gordon Growth Model, gives a fair value estimate of $384 assuming a desired return of 8% and dividend growth rate of 5.5%.
Final Thoughts on Lockheed Martin
Lockheed Martin has demonstrated consistent dividend growth based on revenue and earnings growth. Today, the company has a record backlog of about $150 billion, which should drive future growth for years to come. The current yield is over 3% and dividend safety is solid. Defense stocks did poorly on average in 2020 from a total return perspective and Lockheed Martin was not an exception. The stock is arguably undervalued based on historical multiples and dividend growth rates.
Furthermore, Lockheed Martin is one of my Top 5 Foundational Dividend Growth Stocks. Small investors may want to research this high-quality stock further.
Disclosure: Long LMT
Author bio: Dividend Power is a self-taught investor and blogger on dividend growth stocks and financial independence. Some of his writings can be found on Seeking Alpha, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial blogs. He also works as a part-time freelance equity analyst with a leading newsletter on dividend stocks. He was recently in the top 10% out of over 7,853 financial bloggers as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.
Disclaimer: Dividend Power is not a licensed or registered investment adviser or broker/dealer. He is not providing you with individual investment advice. Please consult with a licensed investment professional before you invest your money.