Lockheed Martin reported 4Q 2017 earnings today that were in line with expectations. The initial 2018 outlook lifted the stock as LMT is using a lower tax rate to fund growth initiatives as well as to contribute $5B to its pension plan (always a big cost item for defense primes), which is improving earnings longer-term. Our price target is increasing to $374 as the F-35 deliveries gets closer to its target of 160/year.
Current Price: $345 Price Target: $374
Position Size: 3.27% TTM Performance: +36%
Thesis Intact. Key takeaways from the quarter:
1. 4Q2017 sales +10% segment operating margin +44bps; total sales for 2017 were +8% while segment operating margin -77bps
a. Sales were up +8% for the year (Aeronautics +13%, Missiles & Fire Control +9%, Rotary & Mission Systems +6%, Space +1%). The growth was driven by the F-35 ramp up
b. Reported operating margins increased 44bps in 4Q 2017. Margins were helped by an increased interest globally in their THAAD and PAC-3 missile defense system following the escalating nuclear threat with North Korea
c. 2017 adjusted EPS was $13.33, +7.7% y/y. The one-time net tax reform impact in 4Q17 was ($6.69)
d. The company reached a record cash from operations level of $6.5B in 2017
2. Management provided its initial 2018 outlook
a. Sales guidance of $50-51.5B, a lackluster growth of less than 1% for 2018 but 2019 and after going back to 4-5%/year
b. Segment operating profit of $5.2-5.35B (10.4% mid-point margin), consolidated operating profit $6.83-6.98B, positively impacted by pension cost adjustments
c. $5B accelerated cash contribution to its pension plan thanks to new tax reform
i. Extra contribution meets required payments until 2021
ii. Tax rate to be 17-18%, should drive a $500M annual benefit
d. GAAP EPS of $15.20-15.50, higher than consensus but mostly due to the new tax rate
e. Cash from operations of at least $3B, with a goal of reaching $7B in 2019 & 2020
i. Cumulative CFO 2018-2020 to reach at least $17B
f. Commercial helicopter sales to remain muted. Would need oil price to remain at $65/barrel longer to see a ramp up
3. Valuation is supported by rising military budget under Trump Administration and F-35 deliveries ramp up until 2025
a. The multiple is supported by prospects of a rising military budget, modernization efforts and geopolitical risks
b. New price target of $374
c. Dividend yield of 2.3%, FCF yield of 5.73%
LMT Thesis:
• Lockheed Martin is a primary beneficiary from the replacement cycle for aging military aircraft and ships
• Excellent management team focused on returning capital to shareholders
• Strong cash flow and financial position