Why Lockheed Martin Is A Long-Term Investment

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

National security and aerospace defense have always been vital issues in American government, often being a sole area in which the administration refuses to compromise. This makes the business of supplying the aerospace industry lucrative, particularly after the terrorist attacks of September 2001, which brought the reality of military threats home. One of the world’s largest defense contractors is Lockheed Martin (NYSE: LMT) a global American company that supplies military aerospace technology and security products. In recent years Lockheed Martin has been named the top US federal contractor in terms of revenue, with around 85% of its annual revenue (that’s around $40 billion) being made up of domestic government contracts.

It isn’t surprising, therefore, that there are many investors with shares in the company; with strongly established links to the US government in addition to foreign entities, as well as a small proportion of private commercial contracts, steady and consistent demand levels can be relied upon. Although the aerospace industry as a whole has seen a slight decline over the past trading year, Lockheed Martin has retained a worthy market performance, recovering from a $66.36 low in August 2011 to a position now of trading at around $90 per share. This upward movement remained above the stock’s 50 day moving average, a clear sign that it would display a strong and sustained rise. Investors who pitched their bets prior to this positive stock movement will be reaping the rewards of healthy returns – but it is less clear whether or not investment in Lockheed Martin is still an attractive prospect.

The latest news from the company is that the cost of developing and producing the popular Lockheed F-35 aircraft has risen by 4.3% since 2010, statistics revealed by recent figures released by the Pentagon. To the untrained eye, this increase may seem minimal – but due to the size of the F-35 aircraft program (the largest military aerospace project ongoing in the US) it is in fact highly significant, and could affect the market. The Pentagon’s current program involves operating 2,443 F-35 fighter aircrafts worldwide, which now costs around $1.1 trillion per year. This is a rise from $1 trillion last year; in addition to increased development and supply costs, increasing fuel prices and maintenance cost rises have contributed to this uprising. A cost assessment carried out by an independent financer at the Pentagon had projected the project would rise to an inflation-adjusted $382 billion; costs are now in fact exceeding $395 billion.

According to the official word of the Pentagon, these cost increases (which have led to the defense project being delayed) are down to issues regarding aircraft design technical problems. But outsiders aren’t convinced this is the full story. Some independent sources claim around 75% of the unanticipated ‘cost increases’ have come about due to changes in the way in which calculations of cost estimates are carried out. Additionally, the government itself may be the reason behind the slow-down of the project. The new Obama administration brought with it new plans, which had to be funded. Originally, there were plans to produce 1600 new F-35 aircrafts by the conclusion of the President’s second term in office. Instead, only 365 were produced, in order to allocate budget funds to other government projects. This decreased the potential for economies of scale to be exploited in mass production. In my opinion, the government’s minimalistic approach to military funding is certainly one source of blame. If it had been bolder in providing project funds, the program would have been quicker and more efficient. The engines of the F-35 aircrafts were produced by United Technologies, which, with a larger demand scale, could have significantly lowered production costs.

 

Boeing (NYSE: BA), Lockheed Martin’s closest market rival, is yet to react to the news of the slowdown of the F-35 program. As Lockheed Martin currently dominates the demand of the US government for military aircraft technology, Boeing should remain relatively unaffected by the cost rises. Back in the 1990s, the Lockheed Martin X-35 design was selected above the Boeing X-32 design for the US Joint Strike Fighter program, resulting in Boeing losing out on the contract. Since then, it seems the company has thrived to succeed in other areas of its production. In November 2010, the Defense, Space and Security division of Boeing was selected to compete for NASA contracts relating to launch vehicle and propulsion technology (alongside aerospace technology giant Northrop Grumman). The company is also a large supplier to the commercial aircraft industry, an area in which it may chose to focus more now it seems evident the US government is less keen to devote mega-funding to new military projects.

The American defense contractor Raytheon (NYSE: RTN) the globe’s largest supplier of guided military missiles, may be indirectly impacted by the news of cost increases. As the fourth largest supplier of military technology to the US government (by revenue), and the fifth-largest contractor of military products worldwide, the indication that the US is limiting military spending will be bleak. Raytheon is highly specialized in providing aerospace products, with little of the diversification seen in the production of Lockheed Martin and Boeing. In the long run, I believe signs of the US government lowering contract spending could hit Raytheon’s stock price more than its two closest competitors.

But looking at the bigger picture, I don’t think we should get ahead of ourselves. The US will always include military spending as a major component of its budget. Investment in the aerospace industry may not seem overly attractive at the moment, but with the quantity of public contracting involved, I can’t help but recommend it as a safe bet in the long run. Short term investment in Lockheed Martin isn’t advisable. This news of project cost rises could drive the stock to peak and begin to fall, particularly given the news-sensitive nature of stocks of companies with high levels of public funding. My advice would be to wait and see what the coming months bring. 


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