Is Lockheed Martin Headed for Blue Skies in 2013?

The federal budget sequester went into effect March 1, but given the strong performance defense giant Lockheed Martin (NYSE:LMT) has experienced over the past five months, you wouldn’t know it. However, the company has compressed its 2013 outlook to reflect impending spending reductions spurned by sequestration. Will Lockheed Martin be able to keep its momentum despite reduced government funding? Let’s use our CHEAT SHEET investing framework to decide whether Lockheed Martin is an OUTPERFORM, WAIT AND SEE, or STAY AWAY.

C = Catalysts for the Stock’s Movement

Because around 82 percent of Lockheed Martin’s sales are to the U.S. government, the company is highly dependent on the domestic defense budget. Sequestration measures enacted earlier this year require the government to reduce defense spending by $500 billion over the next 10 years. The Department of Defense projects automatic cuts will reduce its budget by around $37 billion this year and $52 billion in 2014. Lockheed Martin announced along with its 2013 earnings report that these budget cuts could reduce its sales by $825 million this year.

Luckily for Lockheed Martin, its industry-leading F-16, F-22, and F-35 fighter jet models may be in the clear — at least for now — as the Pentagon decides how to reduce its budget. Lockheed Martin continues to receive funding from the Department of Defense, including an additional $8.4 billion in funding this year to develop its turbulent F-35 joint strike fighter, a program that is seven years behind schedule. As a result of the domestic spending cuts, CEO Marillyn Hewson indicated that the company might begin concentrating its efforts on its overseas business, which currently makes up around 17 percent of its revenues. Recently, Lockheed Martin announced large contracts to bring its F-35 stealth fighter to both Japan and Israel.

E = Earnings are Increasing Year-Over-Year 

The automatic spending cuts, which began March 1, did not seem to impact Lockheed Martin’s first quarter. In fact, the company posted strong earnings per share of $2.33 — a 14.78 percent increase from the previous year’s quarter. Lockheed Martin has increased earnings in four of the last five quarters, but with revenue growth decreasing in the last three quarters, the company has increased profitability by reducing expenses. These cost-cutting initiatives come mainly in the form of job cuts, but as revenues continue to fall with sequestration measures, Lockheed Martin may not be able to keep reducing its costs. Lockheed Martin announces its second quarter earnings Tuesday.

2013 Q1 2012 Q4 2012 Q3 2012 Q2 2012 Q1
Qtrly. EPS $2.33 $1.74 $2.21 $2.38 $2.03
EPS Growth YoY 14.78% -16.97% 5.24% 11.22% 35.33%
Revenue Growth YoY -1.97% -0.92% -2.06% 3.27% 6.28%

E = Exceptional Performance Relative to Peers?

The entire defense industry is in a tough spot with looming sequestration of the Pentagon’s budget. Let’s see how Lockheed Martin, the biggest government contractor by contracts, stacks up against the other major players: Boeing (NYSE:BA), Northrup Grumman (NYSE:NOC), and Raytheon (NYSE:RTN). All of the companies are trading at a relatively low price-to-equity ratio besides Boeing, mainly because Boeing also has exposure to the commercial aviation industry. Lockheed Martin has a significantly higher return on equity than its peers. Part of this higher ROE has to do with its substantial leverage. However, with a high credit rating and a strong interest coverage ratio, the company’s high debt level should not worry investors for now. Lockheed Martin has a very attractive dividend yield of 4.1 percent and has increased its dividend by at least 10 percent in each of the last 10 years.

LMT BA NOC RTN
Trailing P/E 13.01 19.69 11.08 12.20
Operating Margin 9.15% 17.37% 12.31% 12.22%
ROE 302.40% 64.43% 19.60% 22.91%
Dividend Yield 4.10% 1.90% 2.80% 3.2%

T = Technicals on the Stock Chart are Strong

Lockheed Martin is currently trading at around $112.80, well above both its 200-day moving average of $97.53 and its 50-day moving average of $107.44. The stock has been on a tear since the beginning of March — it’s up around 30 percent since March 4. Additionally, Lockheed Martin experienced a “golden cross” — when the 50-day moving average crosses over the 200-day moving average — right around its first-quarter earnings announcement. A golden cross usually indicates strong investor sentiment.

Conclusion

Lockheed Martin has a lot to prove in its second-quarter earnings announcement, which is less than a week away. As the sequester continues to decrease profit margins and revenues on native soil, the defense giant must look elsewhere in order to grow its revenues. Additionally, in order to continue generating earnings growth, Lockheed Martin must keep reducing its costs. The stock currently trades at a relatively low price-to-earnings multiple of 13.01 and has an attractive dividend yield. The automatic spending cuts have not significantly affected Lockheed Martin, but the company could see some reduction in earnings growth and changing investor sentiment over the coming quarters. For now, Lockheed Martin is a WAIT AND SEE.

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