Lockheed Martin Faces Uncertain Times In Light Of Defense Budget Cuts

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Lockheed Martin (NYSE: LMT), a leader in the global security and aerospace market, is shrouded in a dark veil of uncertainty in light of what could be the most bearish period for the U.S. defense industry since 1940. Interestingly, it is not alone. Other players in the industry, like Northrop Grumman (NYSE: NOC) and Raytheon (NYSE: RTN), will also go through a rough patch if the defense budget cuts kick in. What’s even worse is the looming ‘fiscal cliff,’ which will inevitably have many unforeseen ramifications on these defense companies.

Why is Lockheed worse off when compared with its competitors? Lockheed has a high cost structure, something that has inevitably affected its margins. This is clearly represented by the unhinging net profit margins that come in at a mere 6 percent. In addition, it is more leveraged relative to Raytheon and Grumman. This heavyweight is neck deep in debt, as indicated by its bulging total debt to total capital ratio of 73 percent. A dim outlook in the defense sector, coupled with concerns over the company’s ability to improve margins, have pushed investors away from the stock. Indeed, shares outstanding have dipped 36.2 million over the past two years.

While a section of pundits believe that Lockheed, alongside other defense stocks, presents a good value play, I am inclined to disagree. These pundits argue that the defense segment, being as important as it is to the U.S., inevitably attracts a high value. While this is true, I have strong convictions that the new deficit-conscious strategy will produce effects that may well span out into the long haul. In addition, defense stocks’ uncomfortable margins suggest that dividend payouts will take an inevitable plunge in years to come, a factor that automatically reduces investors’ desire to buy shares and wait for a rebound. Narrowing in on Lockheed, it should be noted that its dividend, albeit rising impressively from 2011, has been teetering.

The chart below offers a deeper read.

<img src="/media/images/user_13010/lmt_large.jpg" />

Back in 2003, and all through to 2006, Lockheed’s dividend yield took a huge plunge. A repeat of this was seen yet again after the widespread financial crisis that rocked 2008. I have unfaltering convictions that the current forward dividend yield of 4.97 percent will dip in future years. Although Congress has backed a bill supporting $633 billion for defense (a figure that eases the pressure on defense stock), the bill still needs Obama’s signature. Furthermore, if Obama signs the bill into law, long term prospects will still remain dim considering the fact that Obama’s deficit-conscious strategy will still underlie the defense segment.

How big a blow could cuts deliver?

This is the question that ultimately matters. In all honesty, I am convinced that the probable effects of the blow border on the extreme end. The government directly contributes to building the top line of almost all defense stocks. Both Northrop and Lockheed attribute colossal chunks of their revenue to the Department of Defense. The latter derives close to 85 percent of its revenue from government, while the former rakes in an unbelievable 90 percent of revenue from the government.

This snapshot candidly demonstrates the overt dependence that defense stocks have on the government, and I personally believe that investors will, for some time, exhibit a negative sentiment toward these stocks regardless of the steps that the government takes with regard to the spending cuts.

On the bright side, Lockheed has inked a notable asset acquisition. The Bethesda-based defense bigwig has signed off to acquiring all the assets of CDL, a Canadian software engineering firm. Lockheed CEO Bob Stevens pointed out that the acquisition was instrumental, citing that CDL would be integrated with the acquisition of Procerus Technologies and the May acquisition of Chandler. All these three acquisitions build on Lockheed’s Missions Systems and Training business. The addition of CDL in particular brightens the outlook. The introduction of new technology, specifically IT-related tech, will greatly improve efficiency and results.

In conclusion, I believe that Lockheed is a good play. Nevertheless, broader market conditions suggest that it, alongside its competitors, will be going through a rough patch in the coming months. If I were to weigh a decision of investing in the stock, I would wait and see how the whole fiscal cliff and spending cuts situation pans out. Lockheed is a sell.

muhammadbazil has no positions in the stocks mentioned above. The Motley Fool owns shares of Lockheed Martin, Northrop Grumman, 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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