Defense Industry and Its Troubles

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Last month Lockheed Martin, (NYSE: LMT) a security and an aerospace company recently reported growth in its third quarter. In the most recent quarter operating margins increased to 12.1% and the company has had robust cash generation of $1.6 billion. Lockheed’s financial strength helped to increase quarterly dividends to $1.15 a share.

The company has faced turbulence in between its strong results. It was expected that if President Obama was reelected, defense contractors would take a hit. The price of Lockheed fell from $95 to $90 a share because of the uncertainty in the defense industry. Another reason of concern was Chris Kubasik's lengthy personal relationship with a subordinate employee that resulted in an ethical allegation against him. Kubasik’s impropriety happened at a very sensitive time when there are massive defense cuts and Lockheed has been trying to cut costs by offering its managers incentives to part ways.

Industry rival Boeing (NYSE: BA) announced it is shedding 30% of its management team. This gives a clear picture of what defense industry contractors can expect in future. Boeing's workforce reduction has already saved $2.2 billion since 2010 and should potentially save another $1.6 billion by 2015. Boeing seems to be better prepared than Lockheed as it generates handsome revenues from commercial airplane orders, apart from defense contracts which totaled $22.85 billion in the fiscal year 2012. Boeing has a strong balance sheet with a cash balance over $11.1 billion. It provides a good dividend to its investors and has seemingly never ending commercial and military aircraft orders adding value to its stock.

The growth in Asia, the Middle East, and Latin America will fuel demand for more passenger planes. The cargo business is also expected to grow by about 5.2% annually. The Boeing’s Management predicts that the plane requirements will almost double in two decades, which means that the company will be manufacturing bulk of the projected demand. Boeing is thus the best placed company in the current scenario.

Northrop Grumman (NYSE: NOC) has come out with a new break through, the Firebird, medium-altitude Optionally Piloted Vehicle (OPV). The aircraft has an option of being operated without a pilot and can be commanded from a ground station. Firebird seems to be the perfect replacement for the aging, inefficient, and unsustainable fleet of special mission aircrafts. Firebird should give leverage to Northrop over its peers. Every defense company is trying to tap a survival strategy for itself.

Northrop has also laid off about 600 aerospace workers in Southern California and is further planning to cut 350 electronic systems workers, mainly in the Baltimore area, in addition to 700 workers already sacked from that division. Job cuts seems to be a technique to save costs, but it can come down badly on the company as well as on the industry as a whole.

Lockheed’s Silver lining

The entire industry seems to be affected by the post-election fevor of cuts in government spending on defense. Chris Kubasik's resignation came as a shocker, but his replacement by Marillyn Hewson, a very capable leader, is good news. Hewson has been with Lockheed for nearly 30 years and she was already in the Lockheed team involved in talks with Pentagon officials regarding the F-35 contract. A strain was developing between the two companies regarding the F-35 contract, but now it seems to be at bay for some time.

Lockheed Martin's team had modernized the Air Force's air defense, missile warning, space command and control information technology infrastructure under the ISC2 contract. The company still sustains these contracts which show the trust of Air force on Lockheed. The company has delivered its first U.S. Army Digital Range Training System and has received a $5.1 million Foreign Military Sale contract from the U.S. Air Force. Lockheed has also acquired ChandlerMay, a company that specializes in design, development, integration, manufacturing, and support of fully integrated mission. This acquisition will add Unmanned Aerial Systems (UAS) to the company’s portfolio and thereby adding further diversification.

Final Words

Lockheed has been in slight trouble but the company’s strengths can be seen in multiple areas such as its stock price performance, growth in EPS and increase in net income. The company has received new contracts and few more are in pipeline thus maintaining a healthy flow of revenue. The recent acquisitions should add further value to the company’s strong results. The silver lining of re-election of Obama as President has strengthened India's relationship with America, which should ensure better flow of defense contracts to American companies. The company should be on track once the uncertainties around it clear. The company is a HOLD with a long term perspective as defense is the need of every country in the modern era.

tarunbachhawat has no positions in the stocks mentioned above. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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