4 Reasons To Buy This Stock Now

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

I know as soon as you read the name of the company there will be some who will immediately dismiss this investment idea. However, I'm asking that you read this with an open mind, and stick with me. The fact that this industry has so much doubt surrounding it is precisely the reason you should be considering an investment. Which industry am I referring to? How about some aerospace and defense stocks? For those who are still with me, there is one company that seems uniquely positioned to deliver good returns to investors in the future, despite being part of this much maligned industry.

Big Competition And Big Questions:

There are more reasons, but let me give you four things I've noticed about Lockheed Martin (NYSE: LMT) that make the stock attractive at current prices. As many people know, Lockheed is in the defense business, and with an almost certainty of cuts in defense spending on the table as new budget talks come up, many people have turned a blind eye to the industry. Since the defense business is a capital intensive business, there are a few major competitors, and none are unknowns. When you count companies like Raytheon (NYSE: RTN), Northrop Grumman (NYSE: NOC), and Boeing (NYSE: BA) as your competition, you know you're playing with the big boys. Lockheed faces off with each of these companies on a regular basis for defense and aerospace contracts, and yet the company delivers strong results in the fact of uncertainty.

Hiding In Plain Sight:

One statement that I believe may have been overlooked by some in Lockheed's last earnings report, is the difference in pension contribution the company expects to make compared to 2012. Since many large companies put off fully funding their pension obligations in the economic uncertainty of the last few years, any lower pension contribution level should boost earnings. In 2012, Lockheed contributed about $1.1 billion to its pension plan, and management targeted contributions of about $700 million for 2013. It's not every day that you find $400 million in potential additional earnings hiding in an earnings report, and smart investors can take advantage of this knowledge.

One Thing The Company Can Control Directly:

Admittedly there is only just so much that Lockheed can do about what goes on in Washington, DC. If the government decides to cut defense spending to try and reign in the deficit, the company can lobby and try to influence lawmakers, but they can't make the decisions for them. However, what Lockheed can do is manage their expenses to squeeze as much profit out of each dollar of sales as possible. This has been a consistent theme for the company in the last few quarters. Lockheed has improved their operating margins and last quarter was no different. In fact, in the company's four main divisions, they saw a marked improvement in operating margin in two, margins stayed flat in one, and they were down just 0.1% in the fourth.

If investors fear that Lockheed may not be able to continue this improvement, I say worry not. Looking at the company's gross margin of 8.27%, there is a lot of room for improvement. Their competition like Raytheon has a gross margin of 22.43%, Northrop Grumman sports a margin of 20.86%, and even Boeing is able to post a gross margin of 16.06%. As you can see, Lockheed has a way to go before they would even match their lowest gross margin competitor. Small improvements in margins may not sound like much, but when you keep more of what you make, earnings and cash flow improve.

Speaking of Cash Flow:

One of my favorite ways to compare companies in the same general industry is to look at their free cash flow generation relative to their sales. Since each company is a different size, the best way I've found to make this a fair comparison is to use free cash flow per dollar of sales. This allows the investor to generate a meaningful comparison no matter what the size difference. By this measure, Lockheed is a true standout. In the current quarter, the company generated $0.12 of free cash flow for each dollar of sales. Raytheon and Northrop Grumman were able to generate $0.09 and $0.08 of free cash flow per dollar of sales respectively. Boeing's different business concentration led the company to generate just $0.05 of free cash flow using the same measure. As you can see, Lockheed generates a lot of free cash flow from their sales already, imagine what they could do with better margins as we mentioned above.

Show Me The Money:

One of the best reasons to buy Lockheed today is the company's yield. There is no getting around the fact that Lockheed just raised their dividend by 15%, which gives investors one of the best yields in the defense and aerospace sector. Look at a comparison of the four companies we have been looking at, and you'll see that Lockheed leads the way when it comes to dividends:

<table> <tbody> <tr> <td> <p><strong>Name</strong></p> </td> <td> <p><strong>Yield</strong></p> </td> <td> <p><strong>Free Cash Flow Payout Ratio</strong></p> </td> </tr> <tr> <td> <p>Lockheed</p> </td> <td> <p>4.88%</p> </td> <td> <p>23.88%</p> </td> </tr> <tr> <td> <p>Raytheon</p> </td> <td> <p>3.42%</p> </td> <td> <p>30.22%</p> </td> </tr> <tr> <td> <p>Northrop Grumman</p> </td> <td> <p>3.20%</p> </td> <td> <p>26.00%</p> </td> </tr> <tr> <td> <p>Boeing</p> </td> <td> <p>2.54%</p> </td> <td> <p>31.06%</p> </td> </tr> </tbody> </table>

(source: Yahoo Finance) 

If you are looking for a buy in any industry, it doesn't hurt to pick the stock with the highest yield and lowest payout ratio.

Conclusion

If you look at the overall value offered by Lockheed, you can see there is a lot for investors to like about the stock at current prices. While analysts are only calling for about 5% EPS growth in the next few years, this is somewhat offset by the nearly 5% yield, and history of increasing this dividend. Some of their competition, like Raytheon and Boeing have higher expected growth rates, but I feel more comfortable relying on dividend yield to generate my returns than the expectations of analysts. In addition, as we saw Lockheed may do better than people think. The company will be contributing less to its pension, which should be a positive. If Lockheed can continue to focus on margin improvement, their earnings could surprise the analysts. Even if they just deliver on expectations, the combination of a high yield and low payout ratio means the company should be able to deliver outsized dividend increases for the foreseeable future. For income seeing investors, the best offense in your portfolio could be a defense company.


MHenage owns shares in Lockheed Martin. The Motley Fool owns shares of Lockheed Martin Corp, Northrop Grumman Corp, and Raytheon Company. 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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