Why I Bought Lockheed Martin

By Chad Henage - August 4, 2012 | Tickers: LMT, NOC, RTN, BA | 0 Comments

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I know that some people would say to avoid companies related to the defense industry, specifically because of the budget issues in Washington. However, the opportunities in this field are too good to ignore and for my personal portfolio I decided to choose one company to represent this industry. For multiple reasons, the company I chose was Lockheed Martin (NYSE: LMT).

Since the company recently reported earnings, we get a chance to look behind the scenes at each division to find out what Lockheed is doing right, and what we can expect in the future. However, before we get to the individual divisions, let's see how the company stacks up to some of their primary competitors:

Looking at these numbers, some might assume that I looked for the highest dividend yield and bought that company. However, while it's true that Lockheed pays the highest dividend, that's hardly the only reason I went with the company. Let me run through the four different companies and tell you how I believe they compare. Where Boeing is concerned, I've previously written that though the opportunities in front of this airline producer are vast, the company has not shown its willingness to proportionally reward shareholders. Even though the company is expected to grow the fastest, this may not translate into better returns. Where Northrop Grumman is concerned, there is really one number I focused on and that is the company's near nonexistent growth expectations. With low growth and better dividends elsewhere, Northrop Grumman didn't really stand a chance of attracting my investment dollars. On the surface, it seems that Raytheon could be a good choice. However, what I found was Lockheed Martin had a lower payout ratio and a better history of raising their dividend. So as you can see, while dividend yield did play a part, it was certainly not the only reason to choose Lockheed. Knowing how the company is valued in relation to its competition, next let's take a look at how each division performed.

The company's Aeronautics division produces multiple fighter jets as well as the C-130. Though sales were only up slightly, the company managed to control expenses and increase operating profit by more than 14%. The company's Electronic Systems division, which produces rockets as well as air and ship defense systems, showed a sales increase of just 2%. However, the company again controlled expenses and managed to increase operating profit by just over 10%. The one division that did have a challenge across the board was Information Systems and Global Solutions. This division saw net sales decrease by 4%, which led to a decrease in operating profit of 2.35%. If there was a star of this earnings report, it would be the company's Space Systems division. Net sales increased 18%, and operating profit increased 7.22%. Though sales growth was slow, consistent cost controls are present in every division. This is how overall sales for the company increased 3.48%, but Lockheed managed to increase EPS by over 10%. While I've been impressed by the company's ability to turn mediocre sales growth into better EPS growth, the part I like the best about Lockheed is their financials.

While cash from operations was basically flat, a contributing factor was the company funded pension obligations with $600 million. If you adjust the company's operating cash flow for asset and liability changes, you actually see an increase of 8.45%. In addition, the company's free cash flow payout ratio was just 38.58%. The company also repurchased 2.2 million shares at an average price of about $84.55. On a year-over-year basis, the company has retired just over 5% of their outstanding shares. You can tell that the company is focused on driving down costs, looking at their consolidated operating margin, which increased from 8.6% last year to 10.1% this year. This is a company that knows how to squeeze extra earnings out of every dollar of sales. Last but not least, the company expects cash from operations for the full year of about $4 billion. With financials like these, you can see why I chose Lockheed.

In short, the companies yield of 4.6% is attractive on its own. The company expects to generate significant cash flow, and analysts expect about 6% earnings growth in the future. One of Lockheed's biggest strengths has been a willingness to consistently reward shareholders with higher dividends and share repurchases. Though there are certainly questions about what will happen with defense spending going forward, the company's very low payout ratio should give investors some comfort that their dividend is safe. Longer-term, the company is a leader in the defense industry and appears focused on maintaining that position. I believe if you are going to buy one stock in the defense industry, Lockheed is the class of its industry.

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