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Lockheed Martin: Undervalued, with a Wide Moat
Stock Analysis & Ideas

Lockheed Martin: Undervalued, with a Wide Moat

Lockheed Martin (LMT) is a wonderful company, trading at a wonderful price. The company designs and develops aerospace and defense products such as military aircrafts, and missile defense systems.

Lockheed is likely to be a great long-term investment for several reasons.

To begin with, the quality of its earnings has been increasing. We measure this by breaking down its return on equity into different parts using the DuPont analysis. In addition, it has a measurable competitive advantage, and is undervalued.

Therefore, we are bullish on Lockheed Martin. (See Analysts’ Top Stocks on TipRanks)

DuPont Analysis

Stocks that have a high return on equity tend to have a higher chance of delivering outsized returns. As a result, it’s a very important metric to look at. Lockheed Martin’s return on equity trend is as follows:

Last 12 months: 140%
2020: 276%
2019: Not meaningful
2018: 572%
2017: 159%
2016: 96%

As you can see from the numbers above, the return on equity trend for Lockheed is volatile. From 2018, LMT appears to be on a downtrend. In addition, the return on equity for the last 12 months is also lower than it was in 2017.

On the surface, it may appear that Lockheed’s return on equity is deteriorating, which suggests that the company is losing its ability to generate profits efficiently. However, return on equity on its own doesn’t tell the whole story.

Using the DuPont analysis, we can separate return on equity into three different parts: net profit margin, asset turnover, and equity multiplier.

Net Profit Margin

Lockheed Martin’s profitability trend is as follows:

Last 12 months: 11%
2020: 10%
2019: 9%
2018: 4%
2017: 8%
2016: 8%

As shown above, despite the decrease in return on equity, Lockheed’s profitability has actually been improving over the years.

Asset Turnover

Asset turnover is an important metric because it measures the efficiency of operations. Obviously, investors want a company that continues to improve operations, as it generally leads to increased profitability. The trend for asset turnover is as follows:

Last 12 months: 1.3x
2020: 1.3x
2019: 1.2x
2018: 1.1x
2017: 1.0x
2016: 0.9x

As it turns out, the asset-turnover ratio has been increasing steadily, and mostly aligning with the increase in profitability. Once again, this is despite the fact the return on equity has been decreasing. An increase in both profit margins and asset turnover should increase the return on equity.

Equity Multiplier

The answer to the decreasing returns on equity is the equity multiplier, which is a measure of leverage. Taking a look at this metric, we can see the company has been deleveraging:

Last 12 months: 9.9x
2020: 20.4x
2019: 168.2x
2018: 142.9x
2017: 21.1x
2016: 13.3x

In essence, an increase in return on equity is favorable when driven by increases in net profit margin and asset turnover. It’s much less desirable when primarily driven by leverage.

Although it has been on a downtrend in the last several years, it turns out that it’s actually a good thing because the profit margin and asset turnover ratio have both been improving, while leverage has been decreasing.

Therefore, the quality of Lockheed Martin’s earnings has actually improved.

Competitive Advantage

The aerospace and defense industry can definitely be considered to have high barriers to entry. Before a competitor can even get started it would need a very large infusion of capital because it is very expensive to build out the facilities required..

Even if someone had the money, they would still need to have a very strong understanding of engineering in order to make the right strategic decisions.

As a result, the companies that have already established themselves enjoy a competitive advantage. However, we want to demonstrate just how large Lockheed Martin’s competitive advantage truly is.

We can quantify this by comparing its earnings power value, to the value of reproducing the business. 

Earnings power value is measured as adjusted EBIT after tax, divided by the weighted average cost of capital, and reproduction value can be measured using total asset value. If earnings power value is higher than reproduction value, then a company is considered to have a competitive advantage.

The calculation is as follows:

EPV = EPV adjusted earnings / WACC

$96,456 million = $6,559 million / 6.8%

Since LMT has a total asset value of $52.1 billion, we can easily say that it has a huge competitive advantage.

In other words, assuming no growth for Lockheed Martin, it would “only” require $52.1 billion of assets to generate $96.5 billion in earnings over time.

Risk Factors

As strong as Lockheed Martin is, it doesn’t come without risks. As with many other companies, LMT is not immune to possible supply chain issues.

There may very well be a disruption in its supply chain that adversely impacts its operations.

In addition, some investors may be worried that the government’s spending on the military will decline enough to lead to a decline in Lockheed’s earnings.

However, we believe that any cuts the government makes will be minor, given that the United States tends to use its military to influence other countries.

Wall Street’s Take

Turning to Wall Street, Lockheed Martin has a Moderate Buy consensus rating, based on six Buys and seven Holds assigned in the past three months. The average Lockheed Martin price target of $418.46 implies 14% upside potential.

Final Thoughts

Lockheed Martin is a very important company with a measurable competitive advantage.

Disclosure: At the time of publication, Stock Bros Research had a long position in Lockheed Martin.

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