Lockheed Martin Corporation, a security and aerospace company, engages in the research, design, development, manufacture, integration, and sustainment of advanced technology systems and products in the areas of defense, space, intelligence, homeland security, information technology, and cyber security in the United States and internationally. It also provides management, engineering, technical, scientific, logistic, and information services. The company operates in four segments: Aeronautics, Electronic Systems, Information Systems & Global Solutions (IS&GS), and Space Systems. The Aeronautics segment offers military aircraft, including combat and air mobility aircraft, unmanned air vehicles, and related technologies. Its products and programs comprise F-35 Lightning II joint strike fighter; F-16 Fighting Falcon multi-role fighter; F-22 Raptor air dominance and multi-mission stealth fighter; C-130J Hercules tactical airlifter; and C-5M Super Galaxy strategic airlifter. The Electronic Systems segment provides surface ship and submarine combat systems; sea-based missile defense systems; ship systems integration; littoral combat ships; nuclear instrumentation and control systems for naval submarines, aircraft carriers, and surface warships; air and defense missile systems; air-to-ground precision strike weapons systems; tactical missiles; munitions; fire control and navigation systems for rotary and fixed-wing aircraft; manned and unmanned ground vehicles; mission operations support, readiness, engineering support, and integration services; simulation and training services; and energy programs. The IS&GS segment offers management services, information technology solutions, and advanced technology solutions. The Space Systems segment provides satellites, strategic and defensive missile systems, and space transportation systems; and space shuttle replacement services.
Analysts expect Lockheed Martin to grow earnings 4.94% per year for the next five years and I've assumed they can continue to grow at 3.50% per year thereafter, right around the long term inflation rate. Running these numbers through a two stage DCF analysis with a 10% discount rate yields a fair value price of $126.28. This means that at $92.77 the shares are undervalued by 26.5%.
Over the last 12 months, Lockheed's EPS were $8.71 and it's current book value per share is $7.60. The Graham Number is calculated to be $38.59, which means it is currently overvalued by 140.4%.
Average High Dividend Yield:
Lockheed's average high dividend yield for the past 5 years is 4.21% and for the past 10 years is 3.17%. This gives target prices of $109.39 and $145.11 respectively based on the current annual dividend of $4.60. These are undervalued by 15.2% and 36.1%, respectively. I think the 5 year average high dividend yield is much closer to what you'll see in the future if not a little higher.
Lockheed's average low PE ratio for the past 5 years is 8.76 and for the past 10 years is 11.55. This corresponds to a price per share of $72.00 and $94.94 respectively based off the analyst estimate of $8.40 per share for fiscal year 2013. The 5 year and 10 year low PE price targets are overvalued by 28.9% and undervalued by 2.3%, respectively. The 10 year average PE ratio is skewed a little higher due to the 18 and 15 low PE ratios that LMT shares carried in 2003 and 2004. For the sake of being conservative, I'll use the lower 5 year average PE in my fair value calculations.
Average Low P/S Ratio:
Lockheed's average low PS ratio for the past 5 years is 0.58 and for the past 10 years is 0.63. This corresponds to a price per share of $60.64 and $65.45 respectively based off the analyst estimate for revenue growth from FY 2012 to FY 2013. Their current PS ratio is 0.67 over the last 12 months. The 5 year and 10 year low PS price targets are overvalued by 53.3% and 41.9%. Both of the low PS ratios are close enough to each other, so I'll use the lower 5 year average of 0.58.
Dividend Discount Model:
For the DDM, I assumed that Lockheed will be able to grow dividends for the next 5 years at the minimum of 15% or the lowest of the 1, 3, 5 or 10 year growth rates. In this case that would be 15% since the actual growth rates are higher than 15%. After that I assumed they can continue to raise dividends for the next 5 years at 75% of 15%, or 11.25%, and by 3.50% in perpetuity. The dividend growth rates are based off fiscal year payouts and don't necessarily correspond to quarter over quarter increases. To calculate the value I used a discount rate of 10%. Based on this, Lockheed is worth $144.38 meaning it's undervalued by 35.8%.
Lockheed's trailing PE is 10.69 and it's forward PE is 11.33. The PE3 based on the average earnings for the last 3 years is 11.57. I like to see the PE3 be less than 15 which Lockheed is currently under. Compared to it's industry, LMT seems to be undervalued versus BA (13.41) and overvalued versus NOC (8.85). Compared to RTN (10.38), Lockheed is fairly valued. Against the industry as a whole, LMT is undervalued with the industry carrying a PE ratio of 13.79. All industry comparisons are on a TTM EPS basis. Lockheed's PEG for the next 5 years is currently at 2.24 while Boeing is at 1.28 and Northrup Grumman is -34.30 while Raytheon carries a 1.38 PEG. Against the defense industry as a whole LMT is overvalued with the entire sector carrying a 1.21 PEG. A low PEG ratio is better because it means that you're paying less for the growth of the company.
Lockheed's gross margin for FY 2010 and FY 2011 were 10.20% and 10.10% respectively. They have averaged a 10.05% gross profit margin since 2001 with a low of 7.40% in FY 2004. Their net income margin for the same years were 6.40% and 5.70%. Since 2001 their net income margin has averaged 4.49% with a low of 1.90% in FY 2002. I typically like to see gross margins greater than 60% and at least higher than 40% with net income margins being 10% and at least 7%. Lockheed falls short on both of my margin requirements. Of course each industry is different and allows for different margins, so let's see how Lockheed has done when compared to their industry. For FY 2011, Lockheed captured only 47.4% of the gross margin for the industry and 89.1% of the net income margin. Before I'd feel comfortable investing in LMT I would like to see some progress made on their margins, especially catching up to the industry averages. Their cash-to-debt ratio for the same years were both 0.45 and 0.55. I prefer for company's I'm investing in to have very little debt on their books and to have a cash-to-debt ratio greater than 1. Lockheed isn't quite at that level but they did make progress between 2010 and 2011.
Lockheed's shares outstanding decreased every year since 2002. They've bought back over 27% of the shares outstanding since 2001, with an average of 3.12% purchased each year. By repurchasing shares, Lockheed is able to increase EPS and management can return cash to shareholders this way by increasing the ownership share of the company for all the oustanding shares.
A negative number for the % change value means shares were bought back by the company and a positive value means the shares outstanding increased.
Lockheed is a dividend contender with 10 consecutive years of dividend increases. Their current annual dividend sits at $4.60 for a current yield of xxx%. LMT's annual increase for the last 1, 3, 5 and 10 years have been 27.69%, 21.04%, 23.07% and 25.16%. These numbers are different from the actual quarterly increases since these are based off the dividends paid out during each fiscal year. Their payout ratio has increased right along with the dividend growth rate thanks to the earnings growing slower than dividends. I expect the growth rate to come down over the short term until they can grow earnings faster.
Their FCF per share has been pretty good over the years. Since FY 2001 they haven't had any negative years and only 1 year, FY 2003, with a FCF payout ratio over 100%. Cash flow is the lifeblood of a company, so seeing a low FCF payout ratio is very encouraging.
Return on Equity and Return on Capital Invested:
Lockheed's ROE has averaged 32.76% since 2001 with a low of 1.20% and a high of 73.2%. Their ROCI has averaged 21.7% since 2001 with a low of 0.6% and a high of 50.0%. For both ROE and ROCI I don't necessarily look for any absolute values rather I like to see stable or increasing levels over the long term. Lockheed's ROE and ROCI is on a long term uptrend.
Revenue and Net Income:
Since the basis of dividend growth is revenue and net income growth, we'll now look at how Lockheed has done on that front. Their revenue growth since 2002 has been great at 6.41% per year and their net income has been growing at an 20.38% rate. Since their net income has been growing faster than revenue, their net income margin has increased from 1.88% to 5.71% between FY 2002 and FY 2011. This means that management has been able to get operations more efficient and they are able to keep more pennies from every dollar of sales to reinvest in the company or return to shareholders. Revenue has grown every year since FY 2001, but both revenue and net income growth has been slowing.
The average of all the valuation models gives a fair value $91.86 which means that Lockheed is currently trading at a 0.99% premium to the average fair value. I've also calculated the fair value with the highest and lowest valuation methods thrown out. In this case, the Graham Number and DDM valuations are thrown out and the new average is $92.05 Lockheed is trading at a 0.78% premium to this price as well.
However, doing a quite common sense check shows that the dividends per share would increase past the earnings per share quite quickly if the growth rates I used in my calculations pan out. So we need to lower the dividend growth rate in order to get a more believable value. I've recalculated the DDM using a 9% growth rate for the first 5 years and 6.75% for the next 3 years and kept the 3.50% perpetuity growth rate. In 10 years the payout ratio would still be quite high at 78%. This gives a value of $93.80 which changes the average fair value calculation to $83.43 and $83.93.
Overall, I would say that Lockheed is a little overvalued right now and I would need a bit of a pullback before I would feel comfortable becoming part owner. The potential of the fiscal cliff not being resolved and the automatic cuts taking place is troubling. There's lots of questions surrounding how the defense industry will be effected by the coming changes. I think the defense industry will be fine over the long-term, but for now there's much to concern an investor. Lockheed recently announced a 15% increase in their quarterly dividend, but with the lower growth rate going forward I'm not sure that investors seeking high growth from the dividend will be that pleased over the short term. The 5.00% yield is tempting to start a small position to wait and see how things shake out and get paid to wait for improvement by the company.
I thought we should also take a look at the potential returns that you could be looking at if you buy in at the current level. If Lockheed can grow their EPS at the rates that I used in my DCF analysis then after 10 years their EPS will be $11.44. Applying the 5 year average PE ratio of 10.15 to the EPS would mean that shares would be trading for $116.16. This would be a 125.21% return over 10 years. However we also have to account for the dividends. In that same time you would have received $67.75 in dividends if they can grow dividends at the rates I used in my revised DDM analysis. This would represent a further return of 73.03% if dividends are not reinvested. The 10 year total return would be 198.24%, for an average annual return of 7.08%. Buying at my fair value price of $84.00 would give a total return of 218.93% for an average annual return of 8.15%.
What do you think about Lockheed Martin as a DG investment at today's prices?