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The Pentagon’s prime contractor, Lockheed Martin Corp. (LMT - Analyst Report), posted impressive second quarter 2014 earnings before the opening bell in spite of the uncertain budget environment. The company reported quarterly earnings of $2.76 per share, comfortably surpassing the Zacks Consensus Estimate of $2.66 by 3.8%.
 
Earnings in the reported quarter also rose 4.5% from $2.64 per share in the year-ago quarter. The upcast in earnings was mainly attributable to its strong operational performance. This premier defense contractor is also optimistic about 2014, expecting higher earnings this year.
 

 

Operational Highlights
 
In the reported quarter, total revenues were $11,306.0 million, beating the Zacks Consensus Estimate of $11,070.0 million by 2.1%. 
 
However, the tepid defense budget scenario pulled its top line down by 0.9% from $11,408.0 million a year ago. All segments, except Aeronautics and Mission Systems and Training, recorded year-over-year sales decline.
 
Lockheed Martin ended the year with $77,800 million of backlog, down 5.8% from $82,600 million as on Dec. 31, 2013. Of this, $24,200 million belonged to the Aeronautics segment and $21,100 million to the Space Systems segment. The rest is made up of $13,400 million for the Missiles and Fire Control segment, $11,600 million for Mission Systems and Training and $7,500 million for Information Systems & Global Solutions.
 
Segmental Performance
 
Aeronautics
 
Aeronautics’ quarterly sales increased 13.1% year over year to $3,855 million. The improvement mainly reflects higher sales related to F-35 production and development contracts, along with higher sales from C-130 and C-5 programs.
 
Segmental operating profit jumped 11.3% year over year to $453 million while operating margin contracted 10 basis points (bps) to 11.8%.
 
Information Systems & Global Solutions
 
Information Systems & Global Solutions’ quarterly sales decreased 7.6% to $1,941 million. The decline reflects lower net sales and completion of certain programs. The negatives were, however, partially offset by the initiation of certain U.S. government IT programs and integration of recently acquired companies.
 
Segmental operating profit came in at $175 million, down 10% year over year while operating margin decreased 20 bps to 9.0% year over year.
 
Missiles and Fire Control
 
Missiles and Fire Control segment’s quarterly sales dropped 7.4% to $1,891 million. The decrease reflects lower net sales for various technical services programs and for air and missile defense programs.
 
Segmental operating profit decreased 9.4% to $345 million and operating margin contracted 40 bps year over year to 18.2% in the reported quarter.
 
Mission Systems and Training
 
Mission Systems and Training segment’s quarterly sales of $1,771 million remained almost on par with year-ago levels. The nominal increase in segment revenues reflects higher sales for integrated warfare systems and sensors programs.
 
Segmental operating profit dropped 32.7% to $185 million while operating margin shrank 510 bps to 10.4%.
 
Space Systems
 
Space Systems’ segmental sales decreased to $1,848 million in the second quarter from $2,087 million in the comparable period last year. The 11.5% decline reflects lower net sales for government satellite programs.
 
However, segmental operating profit fell 10.1% to $248 million while operating margin climbed 20 bps to 13.4% from 13.2% in the year-ago quarter.
 
Financial Condition
 
Cash and cash equivalents were $3,436 million at quarter end versus $2,617 million at year-end 2013. Long-term debt rose slightly to $6,169 million from $6,152 million at 2013 end.
 
The company repurchased 0.8 million shares for $124 million in the second quarter. The company has already declared that it will freeze its defined benefit pension plan and move active salaried workers to an enhanced defined-contribution program. It disbursed $421 million as dividends in the reported quarter.
 
Guidance
 
Lockheed Martin reaffirmed its top-line expectation for 2014 in the range of $44,000 million to $45,500 million, with orders in the $41,500–$43,000 million range. International sales are expected to account for about 20% of 2014 revenues.
 
The company boosted its earnings forecast to the range of $10.85–$11.15 from the earlier expectation of $10.50–$10.80 for 2014. 
 
Lockheed also expects higher cash from operations of approximately $4,800 million for the year compared with its previous forecast of $4,700 million.
 
Outlook
 
Considering that the U.S. military budget is increasingly under pressure, Lockheed Martin’s better-than-expected second quarter results are commendable. Also, the company continued to generate strong cash from operations while maintaining its cash deployment strategy.
 
Given the vital role played by satellites in the military space, Lockheed Martin is looking to bolster its satellite product coverage by increasingly investing in R&D and acquisitions. Last month, a $452.0 million contract was awarded to Lockheed Martin Space Systems Co. Per the contract, the company will provide reentry system/reentry vehicles (RS/RV) subsystem support as well as procure MMIII RS/RV subsystem and related support equipment.
 
Lockheed has also inked a deal to buy Zeta Associates, Inc. The acquisition is anticipated close in the third quarter of 2014. Following the completion of the acquisition, Zeta Associates will merge with Lockheed Martin’s Space Systems division. In May 2014, Lockheed purchased Astrotech Space Operations, a company specializing in prelaunch processing of satellites.
 
Going forward, varied product offerings, strong program execution and cost reduction measures will help the company to sustain its profitability.
 
Lockheed Martin has a Zacks Rank #2 (Buy). Other well-ranked defense stocks worth considering include Huntington Ingalls Industries Inc. (HII - Snapshot Report), Embraer S.A. (ERJ - Analyst Report) and Northrop Grumman Corp. (NOC - Analyst Report), all with a similar rank as Lockheed.

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