Lockheed Martin Stock Explodes With Huge Multiple Expansion And Growth Ahead (NYSE:LMT)

In April, I reiterated my buy rating for Lockheed Martin (NYSE:LMT) stock with a $499 price target despite the stock having dropped post-earnings. Fast forward to August and the stock is trading at $555 per share after reporting its second quarter results trading 20% higher easily outperforming the stock markets. In this report, I will be discussing the most recent earnings, the updated outlook, assess the risk and opportunities and update my price target and rating for Lockheed Martin stock.

Why Our Lockheed Martin Analysis Matters To You As An Investor?

I mostly cover stocks in the aerospace & defense, airline, airport infrastructure and related industries and that is not necessarily because those are the industries I like best, but with an aerospace engineering background those are the industries I am best positioned to cover with a qualitative as well as quantitative approach. Lockheed Martin is one over 100 names that I cover in these industries and as a result by following my work you get a pretty complete view of the industry. In individual analysis on companies, it is not the aim to compare companies to see which one has the highest upside because with over 100 names covered it is simply too much to do so.

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Lockheed Martin Sales Grow Strongly

For the second quarter, analysts were expecting Lockheed Martin to report $17.01 billion in revenues and normalized earnings per share of $6.45. Lockheed Martin beat estimates reporting revenues of $18.1 billion and core earnings per share of $7.11 and GAAP earnings per share of $6.85. Segment operating profits came in at $2 billion for a 11.3% margin. Sequentially, revenues grew 5% and earnings grew nearly 18% while year-on-year revenues increased 9% and segment operating profits increased 11%. The improvement in revenues and segment profits can be seen as an indicator of robust demand and easing supply chain issues. Book-to-bill ratio during the quarter was healthy at almost 1x while the backlog stood at $158.3 billion compared to $158 billion a year ago. The stable backlog and book-to-bill ratio shows that the growing revenues are firmly supported by demand trends.

Year-to-date free cash flow was $2.76 billion compared to $2 billion a year ago. The increase was driven by improvements in working capital, which I believe again show that supply chain challenges are easing somewhat, as well as timing of receipts and lower CapEx.

Lockheed Martin Aeronautics Results Driven By F-35 And F-16

Aeronautics revenues grew by 5.9% or $402 million to $7.28 billion driven by higher sustainment for the F-35 and a production ramp up on the F-16 program. The F-35 sustainment growth was around $335 million and the growth of F-16 production drove $105 million in sales. Earnings grew 4.6% as margins softened due to lower net favorable adjustments on a classified program. While the supply chain health is improving, changes to cost estimates show that the supply chain issues are not fully behind us.

The highlight for the quarter was that Lockheed Martin restarted F-35 deliveries after a year-long pause driven by complications on the TR-3 upgrade. The midway that Lockheed Martin found was the implementation of a truncated version of TR-3. For F-35, the restart of deliveries is important as there are over 100 fighter jets that have been built and are awaiting delivery. Over the course of the past year that has been a pressure as no delivery payments were received while costs were incurred for building the jets and cost of the TR-3 upgrade. Over the course of the next 12-18 months, we will see the inventory of the F-35 jets being delivered which should provide a tailwind to the cash profile.

Missile And Air Missile Defense Solutions And Cost Efficiency Drive Missile & Fire Control Earnings

Missiles and Fire Control sales surged by 12.6% or $347 million to $3.1 billion driven by higher tactical and strike missile sales as output is increasing on the Guided Multiple Launcher Rocket System and Long-Range Anti-Ship Missile programs. Margins increased by 100 bps driving earnings higher by 21.3% to $450 million. This was driven on favorable catch-up adjustments on the Apache and PAC-3 programs. Interesting to note is that the production ramp up contribution did not trickle through to the profit line as contract mix offset the $30 million in profit gain from the higher productions.

For the time being, we see that demand for missiles and air defense systems remains elevated with Lockheed Martin ramping up production. This is of course driven by the use of the equipment in Ukraine and demand elsewhere and should add to the growth prospects of the segment.

Lockheed Martin Rotary & Mission Systems Sales Grow But Margins Fall

Rotary and Mission System sales were up 16.7% or $651 to $4.55 billion; Growth was broadly supported with $420 million driven by higher volumes for radar programs and the Canadian Surface Combatant program as well as laser system program ramp up. Furthermore, there was $160 million sales for Sikorsky helicopters driven by the Black Hawk and the CH-53K.

Profits grew by $41 million or 9% reflecting higher sales partially offset by lower margins. Volume growth accounted for $70 million in profit additions but were partially offset by lower catch-up adjustments due to increased costs for helicopter programs and non-recurring favorable adjustments on a surveillance program.

Space Results Improve On Cost Efficiency

Space revenues increased modestly to $3.2 billion where $110 million in strategic missile and defense program growth reflecting volume on hypersonics and fleet ballistic missile programs were offset by lower commercial and defense space solutions. Margins expanded by 90 bps to 10.8% driving a $346 million profit as contract mix had a higher margin base and cost efficiency on the Fleet Ballistic Missile Program.

Lockheed Martin Increases Full Year Outlook

For the full year, Lockheed Martin has lifted its low-end guidance for revenues by $2 billion and $1.5 billion at the high end which effectively increases the guidance and narrows the guidance range. Segment operating profits have been guided up by $175 million at the low-end and $125 million at the low-end guiding for margins around 10.5%.

The upward revision is broadly carried by all segments with $350 million higher aeronautics sales, a $500 million increase for mission and fire control, a $850 million increase for rotary and mission systems and $300 million in space while margins for RMS segment margins have dropped 50 bps due to helicopter program costs while 40 bps was added to the margins for space on strong execution and cost efficiency while the other segments were stable on the margin assumptions. For MFC, there is a cost drag of $325 million due to losses on a classified program. $100 million has been absorbed to date with another $225 million to be absorbed in the balance of the year.

What Are The Risks And Opportunities For Lockheed Martin?

I don’t see major risks for Lockheed Martin, obviously if there are changes to defense budgets over the longer-term that could alter the growth profile but we continue to see healthy demand as well as a healthy backlog. F-35 deliveries are restarting which should bring in some cash. Full implementation of the TR-3 upgrade could eventually be a risk, but I don’t expect anything similar to a year-long grounding of the fighter jet. The supply chain also remains a watch item, but we are seeing signs of the defense industrial base recovering somewhat from the supply chain issues which could unlock further growth in support of demand.

Lockheed Martin Stock Remains A Buy On Multiple Expansion Prospects

To determine multi-year price targets The Aerospace Forum has developed a stock screener which uses a combination of analyst consensus on EBITDA, CapEx and free cash flow along with the most recent balance sheet data, cash flow statements and my assumptions on debt repayment, share repurchases and dividends. Each quarter, we revisit those assumptions and update accordingly and if need be, we supplement our own estimates if key items such as for example acquisitions are not reflected in estimates yet. The estimates are not bases on any guidance provided by the companies we cover, but by a strong combination of consensus and my own estimates.

If we look at the stock price projections which include a 1% lift to EBITDA for FY24-FY26 and primarily in 2026 and a free cash flow generation lift of 2% which is also more backloaded towards 2026, we see that at current stock price Lockheed Martin is not cheap. In fact, against the median it is actually overvalued by now. So, lower prices could offer a more compelling and shielded entry point. However, I believe that there also is good reason for Lockheed Martin stock to trade in line with peers. If we would let the stock trade in between the peer group and the company median there would still be 6% upside and towards 2026 at peer group valuation the stock would have 41% upside. That is a lot of upside, but we also note that supply chain issues are easing and demand remains healthy. Lockheed Martin is increasing production for key missile programs and in some cases those ramp ups will only be completed towards the last few years of this decade and I believe that is an indication that demand is expected to be robust. Furthermore, weapon system development in the areas of hypersonics and hypersonics defense also drives growth and demand for air missile systems is likely to remain robust on elevated defense budgets globally. On the F-35 program, we see strong international customer interest that once translated into sales and deliveries will drive sustainment tail revenues for decades to come. So, a EV/EBITDA multiple expansion closer towards the peer group would not be absurd given the prospects and the strong product portfolio that Lockheed Martin has.

Conclusion: Lockheed Martin Is Attractive For Long-term Investors

If you are looking for near-term fundamental value against company median valuation, Lockheed Martin admittedly has little to offer. However, into the longer term there are significant growth opportunities that in my view justify multiple expansion. On top of that, Lockheed Martin is returning virtually all its free cash flow to shareholders in the form of growing dividends and stock repurchases without its debt spiralling out in the years ahead. With that in mind, I believe that there also is a case for long-term investors to build a nice yield on cost and enjoy higher share prices as valuation multiples expand.