LMT 4Q17 earnings results are in line, 2018 initial guidance shows positive impact from tax reform

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