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Lockheed Martin Corporation (LMT - Analyst Report) has received a $66 million follow-on contract from the Missile Defense Agency to continue development of the Terminal High Altitude Area Defense (THAAD) Weapon System.

The Advanced Capability Development contract is a five-year, Indefinite Delivery/Indefinite Quantity award. The initial task order provides three years of engineering technical services including: flight test planning, maintenance of laboratory capability, and execution of Ballistic Missile Defense System studies and threat assessments. THAAD is the only missile defense system with the operational flexibility to intercept in both the endo- and exo-atmospheres to provide versatile capability to the warfighter. 

Lockheed Martin is a world leader in systems integration and the development of air and missile defense systems and technologies, including the first operational hit-to-kill interceptor.  It also has considerable experience in interceptor design and production, infrared seekers, command and control/battle management, and communications, precision pointing and tracking optics, as well as radar and signal processing.  The company makes significant contributions to all major U.S. missile defense systems and participates in several global missile defense partnerships.

Lockheed Martin is the largest U.S. defense contractor with a platform-centric focus that guarantees a steady inflow of follow-on orders from a leveraged presence in the Army, Air Force, Navy and IT programs. We expect the company to benefit from a strong defense focus on a number of its platform programs, such as the C-130 Hercules & C-5 Galaxy transport aircrafts, F-16 Fighting Falcon multi-role jet, MH-60 Helicopters, the Advanced Extremely High Frequency & the Global Positioning Satellite III system satellites, the Littoral Combat Ship, and the Aegis Weapons System.

Going forward, we believe Lockheed Martin has significant upside potential based on the Obama administration’s focus on Intelligence Surveillance Reconnaissance (ISR), unmanned systems, force protection, cyber-security, and missile defense. It already sits on an order backlog of approximately $80.7 billion at the end of the fourth quarter of 2011.

On the flip side we must remember that a large percentage of Lockheed Martin’s business comes from the US government (82% of sales in 2011). Budget deficits and political uncertainty make future defense budgets vulnerable to cutbacks.

Going forward, Pentagon is seeking to trim about $487 billion in defense spending over 10 years to meet deficit reduction targets. Also, U.S. economic fundamentals are basically being kept on a leash as the Euro-crisis continues to cast its spell over financial markets, risking further cutbacks in future defense budgets.

Lockheed is also worried about the future of the F-35 Joint Strike Fighter. The F-35 is Pentagon’s biggest weapons program, at an estimated cost of $382 billion, for development and purchase of planes. The downsized defense budget aims to wriggle out most of the savings from this program.

The budget proposal for fiscal 2013 suggests a deduction of $1.6 billion from the F-35 program by eliminating 13 planned aircrafts. The budget proposal provides $9.17 billion for 29 F-35 aircrafts, 2 less than what was sanctioned for fiscal 2012. There are also proposals to delay the procurement plan under the F-35 program, reducing its planned purchase order from 423 to 244 during the period between fiscals 2013 and 2017.

The U.S. Defense Department estimates that this would bring in a total of $15.1 billion in savings. Any more snips at the F-35 program would greatly affect the fortunes of the world’s largest stand-alone defense company. The scissors are at work on Lockheed’s Thaad missile interceptor program as well, which at a conservative estimate would bring in $1.8 billion in savings through 2017.

Given the budgetary cuts and overall scenario, it would not be too pessimistic to advise investors to adopt a wait-n-watch approach for the defense and aerospace goliath. This justifies the Zacks #3 Rank, which translates into a short-term Hold recommendation. Considering the company’s business model and fundamentals, we maintain our long-term “Neutral” recommendation on the stock. This is in sync with its peers like The Boeing Company (BA - Analyst Report) and Northrop Grumman Corporation (NOC - Analyst Report).

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