Everyone is a value investor in one form or another. Indeed, no one buys a stock simply because it is expensive, but rather because they believe in the potential for future appreciation in the value of the investment.
A One differentiating factor is the length of time one is willing to hold. For example, short-term day traders prefer volatility and would like to see rapid stock price appreciation, while long-term investors prefer to accumulate at value levels and are willing to give up short-term gains in favor of wealth compounded over the long term.
This brings me to Lockheed Martin (NYSE:LMT), which I consider to be a high-quality, worthwhile company for long-term investors, and which has not produced the type of rapid growth that short-term investors would like to see. As shown below, LMT’s stock price has stagnated the last 3 months, and is down 7% year to date, well underperforming the S&P 500 (TO SPY).
I last covered LMT here in November last year, with a “Hold” rating, highlighting its strong order book amid global tensions and its fair valuation. It seems my rating at the time was reasonable, since the stock price fell 5% since my last article (-2% total return including dividends), and was outperformed by the 20% rise. of the S&P 500 over the same period. .
In this article, I take stock and explain why investors, weary of a frothy market, might want to consider LMT right now for potentially high returns from here, so let’s get started!
Lockheed Martin strikes me as one of those companies that an investor can hold for the long term without having to worry constantly. Indeed, unlike a “normal” company subject to changing consumer tastes and creative destruction, LMT benefits from a renowned technical base in the field of defense and long-term contracts.
This includes LMT’s signature F-35 program, which is the largest defense acquisition program ever awarded by the U.S. Department of Defense and is expected to last until the 2060s. It is worth noting that LMT has begun developing the F-35 in 1995. This compares favorably to the pharmaceutical industry, for example, which sees “only” 20 years of patent protection on new drugs brought to market.
LMT’s long-term contracts in segments beyond the F-35 to include helicopters, missile defense systems and space systems have resulted in a streak of revenue growth that is rather insensitive to economic cycles. As shown below, LMT sales have more than doubled over the past 20 years and have been rather immune to the 2008-2009 and 2020 recessions.
Additionally, unlike other industries that bear the brunt of development costs without any promise of market acceptance, defense contractors like LMT are paid to develop their weapon systems after their design and their bids were approved by the issuing defense agency. These inherent characteristics and pricing power, due to acquired expertise, translate into respectable margins for LMT, as evidenced by its A+ rating for profitability and an industry-best return on total capital of 22.6%, comparing favorably to the industrial sector median of 7.1%.
LMT’s history of steady growth, combined with shareholder returns in the form of dividends and share buybacks, have resulted in respectable total returns. This is reflected in its 301% total return over the past decade, surpassing the S&P 500’s 212% and Boeing’s 121% (B.A.), and 239% of General Dynamics (DG), while being beaten by Northrop Grumman’s 385% total return (NOC), as shown below.
Meanwhile, LMT continued its growth trajectory this year, with revenue growth exceeding management’s expectations. This translates to revenue growth of 2% on an annual basis, to $16.9 billion during the third quarter, and revenue growth of 3.6% on an annual basis for the first nine months of the year, to 48.7 billion dollars. LMT also generated an impressive $2.5 billion in free cash flow during the third quarter.
With its long-term view of future cash flows and expected development costs, LMT is able to return nearly 100% of its FCF to shareholders in the form of dividends and share repurchases. Also encouraging, LMT increased its share repurchase authorization by $6 billion for a total authorization of $13 billion. Based on LMT’s current market capitalization of $112 billion, this equates to a potential 11.6% reduction in the outstanding float at the current market price. As shown below, LMT has reduced its outstanding shares by 22% over the last 10 years.
Looking ahead, LMT is well positioned to benefit from demand not only from the United States, but also from around the world in Europe, Australia, and Asia for its F-35s and its defense systems. This includes a recent major signing announced in late December for the South Korean government to order 20 F-35 of LMT. Morningstar also supports the thesis that LMT stands to benefit from geopolitical tensions, as noted in its recent report. analyst report:
Lockheed stands to benefit from the recent and predictable increase in U.S. defense spending, driven in the near term by munitions resupply orders from Ukraine, whose forces are spending them faster than they can produce them. Longer term, the Pentagon has prioritized modernizing the military’s ability to counter aggression from several so-called great power rivals, namely China and Russia, while also managing terrorist threats and hot spots like Iran and North Korea.
Risks to this thesis include the fact that LMT’s fortunes are tied to appropriations for defense spending by the US Congress. While I do not see any potential for reductions in defense spending in the near term due to the aforementioned global tensions, it is a risk worth keeping in mind. Other risks include the possibility of interest rates rising, which would increase borrowing costs.
This risk is, however, mitigated by LMT’s strong balance sheet, with one of the lowest leverage ratios among its peers. LMT has a TTM net debt/EBITDA ratio of just 1.35x, below the 3.0x level generally considered safe by rating agencies, and enjoys an A- credit rating from S&P. Encouragingly, LMT’s leverage ratio is down from 1.64x at the end of 2022, driven by lower net debt and higher EBITDA over the past 12 months.
Importantly for income investors, LMT currently yields 2.8% and the dividend is well covered at a 43% The payout ratio. While the yield is not particularly high, it is double the 1.4% yield of the S&P 500 and comes with a 5-year dividend CAGR of 8.2% (comparing favorably to that of the S&P 500). 5.4% for the S&P 500) and 21 consecutive years of growth, making LMT a strong candidate to become a Dividend Aristocrat in 4 years. As shown below, LMT receives high marks for dividend safety, growth, yield, and consistency.
Finally, I see value in LMT at the current price of $453 with a forward PE of 16.7, especially in a frothy market with high valuations in a number of mega and large cap names. LMT’s valuation is also slightly lower than its normal PE of 17.5 over the past 10 years. With a dividend yield of 2.8%, a potential reduction in the number of shares per year of 2% (based on historical trend), and average figure Expected EPS growth from 2025, LMT could produce a long-term total return that could meet or exceed that of the market average.
LMT also trades at a discount to its peers from a price-to-cash flow perspective. As shown below, its price-to-CF ratio of 15.0 is lower than that of NOC, GD and RTX Corporation (RTX).
Takeaways for investors
Overall, Lockheed Martin offers a combination of steady growth and shareholder returns via dividends and share repurchases. Its strong track record, impressive free cash flow generation and global demand for the F-35 position it well for continued success in the defense industry. With a reasonably attractive valuation, especially in a frothy market, and a dividend yield that is 2x the market average and higher dividend growth, I am currently rating LMT a ‘buy’.