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Lockheed Martin Corporation: Time to Book Some Profits
Stock Analysis & Ideas

Lockheed Martin Corporation: Time to Book Some Profits

Lockheed Martin Corporation (LMT) is the second-most valuable aerospace and defense contractor, with a market capitalization of $118.9 billion. It sits only behind Raytheon Technologies Corporation (RTX), whose market capitalization stands at just over $150 billion.

In 2021, when LMT stock would remain rather underappreciated, I wrote several pieces urging investors to trust the company’s robust cash flow generation, in spite of the market’s cautious sentiment towards the defense goliath.

The reason was that quality companies like Lockheed rarely trade at a discount. Thus, the stock’s investment case presented a wonderful buying opportunity at the time.

These days, the market sentiment has completely flipped. Most stocks have traded continuously lower year-to-date following increased market uncertainty over rate hikes, inflation, and elevated global geopolitical turmoil.

However, Lockheed shares have rallied strongly during the same period as investors have flocked to the company’s secured cash flows. The ongoing war in Ukraine has also (unfortunately) been a positive catalyst for the company, as governments all over the world are increasing their defense budgets amid the current situation.

In my view, Lockheed Martin’s results should remain robust for decades to come, as the ongoing war has solidified that we are penetrating into a macro phase of elevated defense budgets internationally.

However, with the stock’s valuation multiple now considerably higher since my initial bullish thesis, I believe it’s an optimal point to book some profits. Accordingly, I am now neutral on LMT stock.

Q1 Results

Lockheed’s Q1 results came in relatively strong. While net sales came in at $15 billion, 7.9% lower versus $16.2 billion in the comparable period last year, this was only due to some short-term supply chain issues.

Net income remained solid as well, reaching $1.77 billion, or $6.44 per share, a modest decline from $1.83 billion, or $6.56 per share in the prior-year period amid the slip in sales.

Despite the ongoing rising costs, Lockheed Martin’s bottom line was boosted by exceptional cost management. In fact, Lockheed’s net income margins even grew from 11.3% in Q1 2021 to 11.58% in the latest quarter.

Management reaffirmed its full-year 2022 EPS guidance of $26.7, suggesting that its short-term supply chain headwinds that were previously unanticipated should be resolved through the year.

Additionally, the company’s backlog remained at robust levels. At $134.23 billion, the company has already secured around two years’ worth of future revenues, implying clear cash flow visibility moving forward.

Growing Capital Returns

Lockheed Martin features a 20-year record of successive annual dividend increases. The company’s five-year dividend per share CAGR (Compound Annual Growth Rate) stands at 9.38%, while its most recent quarterly dividend hike was by 7.7%,

Based on management’s reaffirmed full-year 2022 EPS guidance of $26.7, Lockheed’s payout ratio stands close to a comfortable 42%. Thus, the company should not struggle to maintain its growth track record at a rather satisfactory pace, especially with international defense budgets on the rise.

Additionally, Lockheed has a long history of stock repurchases. For context, over the past two decades, the company has reduced its share count by around 41.5%.

Last year, the company repurchased just over $4 billion worth of stock — a record year of buybacks. In the latest quarter, the company repurchased $2 billion worth of stock, an increase of 100% year-over-year. Thus, the company is likely to break last year’s record.

Buyback volumes are likely to remain robust through the year, taking into account that management’s outlook includes north of $6 billion in free cash flow generation during 2022, which makes for another favorable indicator.

Valuation

With investor demand for Lockheed shares on the rise following the ongoing war in Ukraine, the stock price has risen by around 25% year-to-date.

As a result, with management guidance staying at constant levels, the stock’s valuation has expanded substantially. The forward P/E is now standing at around 16.3. While this doesn’t imply that shares are expensive, the multiple is above the stock’s three-year average, and it’s certainly not cheap in a rising-rate environment.

Despite Lochkeed’s solid dividend hikes, the yield has been pushed lower, close to 2.55%. Consequently, investors’ margin of safety has been compressed lately. This is because the possibility for a valuation contraction has increased, while the lower yield can hardly compensate against such a scenario.

It’s also worth noting that while the fact that Lockheed boosted its stock repurchases is positive, doing so at an elevated valuation has a weaker effect per dollar spent than previously.

Wall Street’s Take

Turning to Wall Street, Lockheed Martin has a Moderate Buy consensus rating based on seven Buys and eight Holds assigned in the past three months. At $490.33, the average Lockheed Martin price target implies 9.8% upside potential.

Takeaway

Lockheed Martin shares were quite attractively priced last year. Year-to-date, Lockheed has outperformed the market dramatically, boosted by a grown investor appetite for defense stocks amid the ongoing war in Ukraine.

While the stock should keep producing resilient cash flow in the short term, backed by its solid backlog and growing results in the medium term driven by growing defense budgets, turning neutral on the stock near an elevated multiple appears like a smart move, in my view.

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