A Bet on the 2012 Presidential Election?
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Lockheed Martin (NYSE: LMT) is the largest defense contractor in the world and operates four different business segments: Aeronautics, Electronic Systems, Information Systems & Global Solutions, and Space Systems. It has a number of important US government contracts that include the F-35 plane, and its major competitors include companies such as Boeing (NYSE: BA), General Dynamics (NYSE: GD), and Northrop Grumman (NYSE: NOC). In 2011, the company had revenues of over $46 billion with operating income of almost $4 billion and net income of $2.655 billion. Total equity for the company is just over $1 billion and the market capitalization is in the region of $30 billion.
The biggest strength of the company is also its biggest weakness as it relies heavily on the US government for business and for funding. This is not a particularly comfortable position given the reduction in budget spending that the US is contemplating and the Department of Defense is planning to cut spending by $500 trillion over the next 10 years. This is bound to have a negative impact on Lockheed's revenues from all segments because of the important contracts that it has on hand. The company has spent a lot of money on developing the F-35 aircraft which is meant as a replacement for the existing aircraft in the Army, Navy and Air Force. Lockheed has had serious problems in the development and as a result, testing has been delayed until 2016. This means that there is some doubt that the company will meet its target, which could lead to problems with both international customers and the US government. The development costs of the F-35 have escalated rapidly, having almost doubled to just under $400 billion since the project was initiated in 2001. Moreover, if the costs and the time schedule should get out of control, increases in the cost per aircraft could mean a reduction in the size of the order and lower profits for the company.
However, Lockheed has its several strengths. For one thing, it has a portfolio of outstanding products and it has the permission of Congress to sell most of its products internationally providing the chance for generating additional revenues. It has also sought to reduce its costs considerably by laying off around 20,000 employees, which should increase profitability in the long-term. Moreover, the US government is unlikely to go overboard on the cuts in defense spending given its strategic commitments throughout the world. Congress has not been very enthusiastic about authorizing cuts in the defense budget, and I suspect that many legislators would actually support an increase to benefit their respective constituencies. However, the presidential election in 2012 will have an impact on the future of Lockheed. If Mitt Romney is elected, the Republicans are unlikely to cut defense spending substantially. However, if Obama is reelected, the cuts could be far more severe.
With the economy not recovering as quickly as one would like, a Republican administration is far more likely to seek a stimulus to the mechanism of increased defense spending. As the biggest defense contractor, Lockheed is likely to benefit, but this is not going to be a cakewalk. The company will have to demonstrate that it can provide the best products with state of the art technology at competitive prices. Lockheed Martin has already moved decisively in several areas such as technology for unmanned craft, since it is becoming increasingly important for the effectiveness of the armed forces. One example of these initiatives is the RQ-170 Sentinel, a stealth reconnaissance drone, which is representative of these efforts as well as the continuing success of the Trident II D5 Fleet Ballistic Missile.
The near-term for Lockheed depends on the F-22 Raptor and F-35 Lightning, in which the company has made major investments. They are both stealth fighters and the high level of technology used to make them the fighter planes of the future. The F-35 will provide the Navy with unparalleled capabilities because it combines stealth features with the capability of vertical takeoff. The F-22 is expected to do likewise for the Air Force. The only problem for Lockheed is to take control of the mounting costs of development and keep them within reasonable proportions so that order volumes will not be affected.
Meanwhile, the near-term for Boeing is looking good as it just reported that it is close to finalizing three deals to sell its 737 MAX jets. This marks a push by Boeing into the Latin American market for this model. General Dynamics recently announced that it won a $6 million contract with the U.S. Army to manufacture mobile shelters. Northrop Grumman also announced new contract add-ons with the Japanese Maritime Self-Defense Force to produce three mine hunting systems.
An investment in Lockheed now partially amounts to a bet on the outcome of the US presidential election. CNN Money has pointed out that, according to estimates, Romney will increase defense spending by $2 trillion over the next 10 years, so a win for him would be good for your investment. However, the order flow to Lockheed in the event of a Romney win would depend on the nature of this expenditure. It would help if the spending concentrates on newer technologies rather than the refurbishment of existing capabilities. Historically, different stocks have done well under Republican administrations. However, in all fairness, I should point out that Obama is hardly as unfriendly to the military as many people seem to think, so his re-election may not be as bad for Lockheed as you might expect. Obviously, he is not going to spend as much as Romney would, but Lockheed will still continue to flourish in the defense business.
I would not recommend an investment in Lockheed at this point in time unless you are inclined to make a bet on the presidential election and favor Mitt Romney to win. Lockheed is still a successful company, and there will be plenty of time to make money from an investment after the presidential election and the announcement of defense spending policies. Hold on to any investment that you may already have, because Lockheed is a solid and successful company and you are bound to benefit in the future.
StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of General Dynamics, Lockheed Martin, and Northrop Grumman. 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.If you have questions about this post or the Fool’s blog network, click here for information.
