Lockheed Martin: What Will Defense Spending Mean for Shareholders?

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The world’s largest military weapons manufacturer, Lockheed Martin (NYSE: LMT), faces a somewhat uncertain future.  Over the past decade, the company has been a rock-solid investment; with several wars going on and ever-increasing defense spending, the company has been able to not only gradually increase shareholder value, but also build up a substantial dividend yield of just under 5%, which is one of the highest among large-cap stocks.  However, with the recent “fiscal cliff” and ensuing pressure to curb Government spending, there is a good chance that the company may be faced with drastically reduced defense spending in the future.

Of Lockheed’s $48.5 billion in annual sales, 82% comes from the U.S. Government, with the balance coming from sales to foreign governments. In other words, Lockheed’s revenue is 100% dependent on military spending. The company operates in four segments.  The aeronautics segment (31% of sales) makes fighter jets, including the F-16 Falcon and F-22 Raptor, and it is currently transitioning more of its efforts to unmanned military aircraft. The Electronics Systems segment (31%) produces electronic equipment for a wide variety of military applications. Space Systems (18%) makes satellites and defensive missile systems, including expendable launch services through a joint venture with Boeing (NYSE: BA).  Finally, the Information Systems and Global Services segment (20%) provides information technology and other advanced technology services. 

Demand for Lockheed’s services is mostly dependent on the growth in the procurement and R&D sectors of the U.S. defense budget.  Over the past decade or so, this has been a very good thing for the company, these sections of the budget expanded at an annual average rate of 7.4%.  However, with the growing budget deficits and the increasing spending on entitlement programs such as Social Security and Medicare, it is extremely likely that military spending will contract over the next several years.  During the earnings call, this is the issue that I would make a priority to address, if for nothing else, to clarify the situation to investors.  If the company comes out and says that it doesn’t anticipate spending cuts to be as drastic as the rumors suggest, investors would look upon that very positively.  On the other hand, if the company has a pessimistic outlook in regards to defense spending, this could be a negative catalyst for some time to come.

In addition to the very high dividend mentioned earlier, Lockheed has one of the most aggressive share buyback programs in the market.  In 2008, there were 409.4 million outstanding shares, which have been reduced dramatically to 323.6 million, a reduction of 21% in just four years.  In fact, analysts project buybacks will be the biggest driver of growth as defense spending contracts.  2012’s consensus earnings are $8.40 per share, which are expected to drop to $8.22 in 2013 which will (possibly) be the first year of significant spending reductions.  However, the projections call for $8.75 per share in 2014, with “share repurchases” the most cited reason by analysts for the increase. 

So, during the earnings call, the 2012 numbers are not the most important thing, as the numbers for this year are relatively predictable (the defense budget is widely known).  As mentioned before, look for the company to address the issue of spending cuts, either positive or negative.  Look for the company to reassure the market that their massive share buyback will continue despite any budget cuts.  If that is the case, and the amount of outstanding shares continues to decline by around 5% per year, this would effectively offset the spending cuts that investors in the company are so afraid of.

KWMatt82 has no position in any stocks mentioned. The Motley Fool owns shares of Lockheed Martin. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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