Introduction
Until I started throwing a lot of money at Texas Pacific Land Corporation (TPL), Lockheed Martin Corporation (NYSE:LMT) was my largest investment.
I have covered the company quite consistently since making it a major position in my dividend growth portfolio when defense contractors were struggling with post-pandemic supply chain issues.
My most recent article was written roughly three months ago, when I called the stock a "Premier Investment Choice."
Since then, LMT shares have returned 10%, beating the 7% return of the S&P 500 by a decent margin.
Even better, it looks like this Bethesda, MD-based company is finally seeing upside momentum in its stock price after going sideways since early 2022.
While major defense contractors have been suffering from budget uncertainty, the sky is clearing up, as a mix of favorable tailwinds, including more favorable defense spending, international demand support, outperforming growth in segments like space, and subdued supply chain pressure is putting Lockheed in a great spot for elevated long-term returns.
In this article, I'll update my thesis and explain why I continue to buy LMT stock on any corrections.
So, let's dive into the details!
More Favorable Spending From Defense Allies
I have roughly 20% defense exposure in my dividend growth portfolio. I follow all major constructors, their suppliers, and overseas peers/competitors.
One thing that stood out in the past earnings season was international demand.
Over the past few decades, the U.S. really stood out among its NATO peers when it came to defense spending. After all, it's the backbone of allied defense capabilities and a nation with significant overseas interests.
However, due to the war in Ukraine, it has become increasingly clear that European allies have neglected their armed forces.
This is what The Wall Street Journal wrote on March 21 (emphasis added):
Europe in recent years has started reversing military cuts made after the Soviet Union collapsed in 1991. During the Cold War, many NATO members spent roughly 3% of gross domestic product on defense. Those outlays plunged in subsequent years.
After Russia seized the Crimean Peninsula from Ukraine in 2014, NATO members agreed to lift their spending to 2% of GDP by this year. Many experts believe European defense expenditures must reach 3% of GDP if the U.S. starts to disengage.
The problem is that achieving this goal would likely mean shifting money from other government programs, which would be a tough move for many socialist governments in Europe.
That said, we are starting to see shifts.
According to the same article, Poland has moved its spending to 4.2% of its GDP, including the procurement of advanced equipment like tanks, helicopters, rocket launchers, and jet fighters.
Then there are Sweden and Finland. The two new NATO members have accelerated the buildup of troops close to Russia and accelerated investments in new equipment.
Total global military expenditure reached $2443 billion in 2023, an increase of 6.8 per cent in real terms from 2022. This was the steepest year-on-year increase since 2009. The 10 largest spenders in 2023—led by the United States, China and Russia—all increased their military spending [...]. - Stockholm International Peace Research Institute (SIPRI)
While non-allied nations like Russia and China contributed to the highest global defense spending growth rate since 2009, we have entered a new phase of defense spending, where a strong defense is no longer a luxury.
Moreover, although I do not believe that Russia will attempt to invade NATO, we see how new technologies are changing the battlefield in Ukraine.
This bodes well for next-gen technologies and companies that provide these products and services.
That's where Lockheed Martin comes in.
Lockheed Is In A Perfect Spot For Accelerating Growth
International demand isn't the only tailwind for Lockheed and its peers.
As reported in the company's 1Q24 earnings call, the FY25 budget request continues to support major programs like the F-35, CH-53K, and UH-60M, along with advanced munitions programs such as JASSM, LRASM, PrSM, Javelin, GMLRS, and PAC-3.
Essentially, all of these are advanced aviation and missile programs. Especially the PAC-3 program is fascinating (to me), as it's the world's most advanced air defense missile. Specifically, in times of rising threats in East Europe, the Middle East, and Asia, protection against advanced missiles is important.
Speaking of missiles, hypersonic programs like conventional prompt strike and long-range hypersonic weapons and the next-generation Interceptor ("NGI") are receiving support.
In fact, the Missile Defense Agency ("MDA") selected Lockheed Martin to deliver the next-generation Interceptor, which is a huge part of the homeland missile defense system.
According to Lockheed, this program employs digital transformation tools and model-based engineering, with the long-range discrimination radar ("LRDR") completing final acceptance to enhance the ability to detect incoming missiles.
After all, shooting down missiles is one thing - detecting them first is just as important.
Unfortunately, not everything is going according to plan.
On May 16, Bloomberg reported that TR-3 upgrades are not going as smoothly as expected, keeping the F-35 from flying its "most advanced" missions until 2025.
The first fully capable TR-3 jets were supposed to be delivered in July 2023, but the program has been dogged by problems with the new software and a new integrated core processor for combat missions. The plane needs the full upgrade before it can carry more long-range precision weapons, gather more information on enemy aircraft and air defenses and operate more effectively with other aircraft. - Via Bloomberg
The good news is that these issues are not bad enough to derail the program, which accounts for almost a third of Lockheed's total sales.
Going back to the good news, the F-16 is still going strong.
Launched in 1978, the F-16 continues to sell well, with the delivery of three block-70 jets to Bahrain in March. So far, a total of five jets have been produced for Bahrain, with eleven more in production.
Moreover, the first two F-16 Block 70 aircraft were also presented to Slovakia's Deputy Prime Minister and Minister of Defense, and the State Department authorized the sale of 40 F-16s to Turkey to further strengthen ties with the Turkish Air Force.
I expect Turkey to get access to a lot more advanced defense products from the U.S. after it allowed the Nordic nations to join NATO.
On top of that, the company continued to upgrade its weapons systems for longer-range capabilities.
The extended range variant of the GMLRS, for example, achieved success in its first operational test with advanced precision.
Furthermore, the U.S. Army awarded a fourth production contract for the Precision Strike Missiles ("PrSM"), increasing production to meet demand.
In general, sales in the Missiles and Fire Control segment surged by 25% year-over-year in the first quarter - or 16% when adjusted for the extra week.
This growth was driven by increased production of tactical and strike missile programs and integrated air and missile defense programs.
Where's The Shareholder Value
Despite some headwinds like lower margins in its Aeronautics segment, the company confirmed its full-year guidance, expecting between $6.0 and $6.3 billion in free cash flow.
That's a big deal.
After all, the midpoint of that free cash flow guidance range translates to 5.5% of the company's market cap!
As a result, the company plans to support shareholder returns with dividends and $4 billion in share repurchases, aiming for mid-single-digit free cash flow per share growth in the long term.
Over the past ten years, LMT has bought back a quarter of its shares, which significantly contributed to a strong total return.
While Lockheed Martin has had its fair share of struggles since the pandemic, it has returned close to 280% over the past ten years, beating the S&P 500 and the SPDR Industrials ETF (XLI) by a wide margin.
Moreover, after hiking its dividend by 5% on October 7, it now pays $3.15 per share per quarter. This implies a current yield of 2.7%.
- This dividend comes with a sub-50% payout ratio.
- The five-year dividend CAGR is 7.9%.
- The company has hiked its dividend for 21 consecutive years.
Even better, its Seeking Alpha dividend scorecard has three A+ ratings!
Not only does LMT come with a fantastic dividend growth profile, but we also need to acknowledge that it has almost exclusively non-cyclical demand, an A- credit rating, and a wide-moat business model.
For example, it is very hard to compete with Lockheed, which not only enjoys fantastic relationships with buyers and suppliers but also produces products that come with massive upfront costs. Often these costs are shared with other peers, which makes it hard for new companies to become part of the "inner circle."
It also helps that most of its products have long lifecycles. Programs like the F-16, F-35, various missile systems, and others were all brought into existence with the aim of maintaining and upgrading them for many decades.
Valuation
Putting a valuation on Lockheed is a bit tricky.
That's mainly because the company is still seeing relatively slow growth rates as it is working its way to a more profitable future, benefitting from new programs and higher demand.
Using the FactSet data in the chart below, LMT had a volatile period since the pandemic. Since 2020, it had three years of negative EPS growth, including 2024, which is expected to see a 6% lower EPS result.
However, after this year, growth is anticipated to be much more consistent, with 2025 EPS expected to grow by 7%, potentially followed by 4% growth in 2026.
Using the company's 17.7x 10-year normalized P/E ratio, we get a fair price target of $520, 12% above the current price.
The current consensus price target is $419, with JPMorgan's target of $518 coming very close to my target.
That said, I am more bullish on RTX Corp. (RTX) and L3Harris Technologies (LHX) due to higher growth expectations and fewer issues with major programs like the F-35.
Nonetheless, I believe LMT is a terrific long-term investment for conservative dividend growth investors, especially if the stock corrects a bit.
The moat and stability of LMT are hard to find anywhere else, which is why I continue to buy this dividend growth stock, expecting it to become a Dividend Aristocrat with at least 25 consecutive annual dividend hikes in a few years.
Takeaway
Lockheed Martin remains a cornerstone in my dividend growth portfolio, continuing to outperform the market despite challenges. The company benefits from increased global defense spending and robust demand for its advanced military technologies.
Recent earnings show promising growth, especially in missile and aerospace programs, positioning Lockheed for sustained long-term returns.
While I have to acknowledge some headwinds, including program delays, the overall outlook remains strong.
With solid free cash flow and a commitment to shareholder returns through dividends and buybacks, LMT is a compelling investment. I will keep adding to my position on any dips, confident in LMT's ability to maintain elevated long-term shareholder returns.
Pros & Cons
Pros:
- Strong Dividend Growth: Lockheed Martin has a stellar dividend track record with 21 consecutive years of hikes and a sub-50% payout ratio.
- Robust International Demand: Increasing global defense spending, especially in NATO countries, boosts Lockheed's growth prospects.
- Stable Cash Flow: Projected free cash flow of $6.0 to $6.3 billion supports significant shareholder returns through dividends and buybacks.
- Wide Moat: Lockheed's established relationships, long product lifecycles, and significant upfront costs create high barriers to entry for competitors.
- Non-Cyclical Demand: Defense spending is less prone to economic cycles, providing consistent revenue streams.
Cons:
- Program Setbacks: Issues like the TR-3 upgrade delay could impact Lockheed's revenue growth and reputation.
- Valuation Concerns: Lockheed's relatively slow growth rates and recent negative EPS growth make its valuation tricky, with potential limited upside if growth remains subdued in the midterm.
- Tough Competition On The Stock Market: Peers like RTX and L3Harris show higher growth expectations and fewer major program issues.
- Budget Dependencies: Lockheed’s success is heavily reliant on defense budget approvals, which can be subject to political uncertainties.
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