Ticker: lmt sector: Industrials Industry



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Ticker: LMT

Sector: Industrials

Industry: Aerospace/Defense Products & Services

Recommendation: BUY

Pricing

Closing Price $110.12 (11/2/07)

52-wk High $113.74 (10/11/07)

52-wk Low $83.74 (10/27/06)


Stop-Loss $95 (recomm.)

Market Data

Market Cap $44.89B

Total assets $29.79B (mrq)

Trading vol 2.6M (3mon avg)



Valuation

EPS (ttm) $6.89 (411M shares)

P/E (ttm) 15.86

PEG 1.38


Div Yield 1.3%

Profitability & Effectiveness (ttm)

ROA 8.57%

ROE 38.21%

Profit Margin 7.08%

Oper Margin 9.65%

Gross Margin 9.39%

Justin Scott

Jhstx6@mizzou.edu




ANALYST NAME

Analyst email address.edu


OCKHEED MARTIN CORP



Profile

Lockheed Martin Corporation principally researches, designs, develops, manufactures, integrates, operates and sustains advanced technology systems, products and services. The Company serves customers in domestic and international defense and civil markets, with its principal customers being agencies of the United States Government. International customers include Allied nations’ governments.

The Company operates in five principal business segments: Aeronautics, Electronic Systems, Space Systems, Information Technology and Global Services (IT&GS) and Integrated Systems and Solutions (IS&S).

During the year ended December 31, 2006, approximately 84% of the Company's net sales were made to the United States Government Department of Defense (DoD), either as a prime contractor or as a subcontractor.






Business Segments

Aeronautics1 (29% of ‘06 total sales)

Aeronautics is engaged in the design, research and development, systems integration, production, sustainment, support and upgrade of advanced military aircraft, air vehicles and related technologies.

Customers include various government agencies and the military services of the United States and allied countries around the world. The segment is dependent on the U.S. military and international governments as customers. In 2006, U.S. Government customers accounted for approximately 78% of the segment’s net sales.

The segment is broken in three sub-segments: Combat Aircraft, Air Mobility, and Advanced Research and Development.



Combat Aircraft

The Combat Aircraft business designs, develops, produces and provides systems support for fighter aircraft. Our major fighter aircraft programs include:

• F-35 Lightning II Joint Strike Fighter – stealth multi-role coalition fighter

• F-22 Raptor – air dominance and multi-mission stealth fighter

• F-16 Fighting Falcon – low-cost, combat-proven, international multi-role fighter

Air Mobility

Air Mobility designs, develops, produces and provides full system support and sustainment of tactical and strategic airlift aircraft. Our major programs include: production, support and sustainment of the C-130J Super Hercules, support of the legacy C-130 fleet, support of the existing C-5A/B/C fleet and development, installation and support of the emerging C-5M Super Galaxy fleet.



Advanced Research & Development

This segment is involved in advanced development programs and advanced design and rapid prototype applications. Advanced Development Programs organization, known as the Skunk WorksTM, has made unmanned air systems one focus of its efforts, and is actively developing the operational concepts and enabling technologies to provide assets in a cost effective manner.


Electronic Systems2 (28% of ‘06 total sales)

The Electronic Systems segment is engaged in the design, research, development, integration, production and sustainment of high performance systems for undersea, shipboard, land and airborne applications.

It has a diverse portfolio of over 1,000 programs. The segment’s most significant programs made up less that 30% of the segment’s sales in 2006. Historically, this diversity has provided a stable backlog and reduced potential risks that can result from reductions in funding or changes in customer priorities.

The segment is dependent on both military and civilian agencies of the U.S. Government as customers. In 2006, U.S. Government customers accounted for approximately 77% of the segment’s total net sales.




The segment is broken into three sub-segments: Maritime Systems & Sensors, Missiles & Fire Control, and Platform, Training, & Transportation Systems



Maritime Systems & Sensors

Provides ship systems integration services, surface ship and submarine combat systems, sea-based missile defense systems, sensors, tactical avionics, port traffic management systems, missile launching systems, aerostat surveillance systems, and supply chain management programs and systems.



Missles & Fire Control

Develops and produces land-based, air, and theater missile defense systems, tactical battlefield missiles, electro-optical systems, fire control and sensor systems, and precision-guided weapons and munitions.



Platform, Training, & Transportation Systems

This business integrates mission-specific applications for fixed and rotary-wing platforms, develops and integrates postal automation and material handling systems, and provides information management solutions for government customers. PT&TS also provides simulation, training and support services, integrates advanced air traffic control systems and develops homeland security systems and products.


Space Systems3 (20% of total sales)

Space Systems is engaged in the design, research, development, engineering and production of satellites, strategic and defensive missile systems and space transportation systems. Through ownership interests in two joint ventures, Space Transportation Systems also includes Space Shuttle processing activities and expendable launch services for the U.S. Government.

The segment is heavily dependent on both military and civilian agencies of the U.S. Government as customers. In 2006, U.S. Government customers accounted for approximately 91% of the segment’s net sales.

It is broken into three sub-segments: Satellites, Strategic & Defensive Missile Systems, and Space Transportations Systems.





Satellites

The Satellites area designs, develops, manufactures and integrates advanced technology satellite systems for government and commercial applications.

The DoD’s prime contractor for the:

AEHF system - next generation of highly secure communications satellites

SBIRS program - worldwide missile detection and tracking capabilities

MUOS program - next generation communications system for mobile warfighter



Strategic & Defensive Missile Systems

Our Strategic & Defensive Missile Systems business has been the sole supplier of strategic fleet ballistic missiles to the U.S. Navy since the program’s inception in 1955.



Space Transportation Systems

Designs and produces various products related to human space flight systems.


Information Technology & Global Services4 (20% of ‘06 total sales)

This segment is engaged in a wide array of information technology (IT), IT-related, and other technology services to federal agencies and other customers.

The segment is heavily dependent on both DoD and non-DoD agencies of the U.S. Government as customers. In 2006, U.S. Government customers accounted for approximately 92% of the segment’s total net sales.


The segment is broken into three sub-segments: Information Technology, Defense, and NASA.



Information Technology

Provides program management, business process management and consulting, complex systems development and maintenance, complete lifecycle software support, information assurance, managed services and enterprise solutions.



Defense

Provides a wide range of professional, engineering and technical solutions and services for DoD, DHS, the U.S. intelligence community and several foreign governments. In 2006, LMT received a number of new and follow-on contracts



NASA

Provides engineering, science and information services at several NASA centers. This line of business has been decreasing in size in recent years.


Information Systems & Solutions5 (11% of ‘06 total sales)

Integrated Systems & Solutions is engaged in the design, research, development, integration and management of net-centric solutions supporting the command, control, communications, computers, intelligence, surveillance and reconnaissance (C4ISR) activities of the DoD, intelligence agencies, other federal agencies and allied countries.

This business segment is heavily dependent on both military and civilian agencies of the U.S. Government as customers. In 2006, the U.S. Government customers accounted for 97% of the net sales of IS&S.


It is broken into two sub-segments: Intelligence Systems & Solutions and DoD C4ISR



Intelligence Systems & Solutions

Develops classified systems in support of the nation’s intelligence community and homeland security. We help plan and define future capabilities, as well as develop large enterprise system solutions.



DoD C4ISR

Responsible for complex systems integration support to provide real-time situational

awareness of actionable decision quality information to the DoD warfighter community.

2007 News6

Contracts

October 25, 2007. Lockheed Martin Corporation Awarded Contract

Lockheed Martin Corporation announced that the Defense Advanced Research Projects Agency has awarded the Company a $2.5-million, 18-month contract to prepare its Plan Understanding and Monitoring Associate (PUMA) for transition into U.S. Air Force Air Operations Centers (AOCs).


October 24, 2007. Lockheed Martin Corporation Announces Contract Win

Lockheed Martin Corporation announced that it has been awarded a $52.5 million contract to develop Combat Convoy Simulators (CCS) - the next generation in a line of convoy simulators produced by the company.


July 31, 2007. Lockheed Martin Corporation Announces Award Of Additional $5 Billion In Multiyear Contract To Build 60 F-22 Raptors

Lockheed Martin Corporation announced that it has received an additional $5 billion from the U.S. Air Force for three lots of F-22 Raptor air dominance fighters. The aircraft will be built at a rate of 20 per year, with deliveries starting in late 2008.


July 18, 2007. Air Force Awards $1.1 Billion Aircrew Training And Rehearsal Support Contract To Lockheed Martin Corporation

Lockheed Martin Corporation announced that the U.S. Air Force has awarded the Company, a 10-year Aircrew Training and Rehearsal Support II (ATARS II) contract. The $1.1 billion contract will provide Air Force Special Operations Command crews with training on a variety of weapon systems. The win extends the Company's role as the principal mission rehearsal trainer for Air Force Special Operations and Search and Rescue aircrews.


June 20, 2007. Lockheed Martin Corporation Announces Contract

Lockheed Martin Corporation announced that is under contract to design, build and deploy the first two MUOS satellites and the associated MUOS ground system. The Navy's Program Executive Office for Space Systems, Chantilly, Va., and its Communications Satellite Program Office, San Diego, Calif., are responsible for the MUOS program. The contract also provides for options on three additional spacecraft. With all options exercised, the contract for up to five satellites has a total potential value of $3.26 billion.


April 17, 2007. Lockheed Martin Corporation and Northrop Dealt New Defense Setback - WSJ

The Wall Street Journal reported that The Coast Guard's decision to drop Lockheed Martin Corporation and Northrop Grumman Corp. from overseeing the service's modernization program is the latest signal that the government wants to reassert control over defense contractors in complex weapons development. The Coast Guard is to announce today that it will assume

management of the 25-year, $24 billion Deepwater program that aims to overhaul ships, aircraft and communications, Department of Homeland Security officials and congressional. The Coast Guard's move follows last week's decision by the Navy to terminate a contract for Lockheed to build the second prototype of a coastal-waters warship.
April 13, 2007. Navy Cancels Lockheed Martin Corporation Ship Pact-WSJ

The Wall Street Journal reported that unable to agree on terms for containing rising costs, the Navy curtailed Lockheed Martin Corp.'s role in developing a small, high-tech warship by canceling Lockheed's contract to build a second prototype of the vessel. Navy officials stated that the two sides couldn't agree on terms for a fixed-price contract for Lockheed's second Littoral Combat Ship, or LCS, to replace the current standard arrangement that called for the contractor to be reimbursed for its costs, plus a fee. Lockheed will complete work on the first prototype of the LCS. It also will be allowed to compete for contracts to build four further ships starting next year.

Chris Kubasik, CFO, said: "We do not think fixed-price contracts are appropriate for development activity because they do not encourage the kind of direct, responsive and collaborative behaviour necessary for success."7

2007 Contract Summary

Even in the midst of a reduction in U.S. Government defense spending, Lockheed has picked up 5 contracts and only lost 2. This shows a positive outlook for future earnings.


Acquisitions

August 17, 2007. Lockheed Martin Corporation Acquires 3Dsolve, Inc.

Lockheed Martin Corporation announced that it has acquired 3Dsolve, Inc. Terms of the transaction were not disclosed. 3Dsolve is a privately held company that creates simulation-based learning solutions for government, military and corporate applications.


April 16, 2007. Lockheed Martin Corporation Acquires RLM Systems, Ltd.

Lockheed Martin Corporation announced that it has acquired the defense and intelligence business of RLM Systems Pty, Ltd., an Australia-based provider of system engineering, software development, integration, and program management services and products. Lockheed Martin acquired the RLM Systems business from RLM Holdings, its joint venture with the Tenix Group, a privately held Australian company. Terms of the cash transaction were not disclosed. The new entity will do business as Lockheed Martin Australia Information Systems & Global Services (IS&GS), a division of Lockheed Martin Australia Pty Limited.


February 1, 2007. Lockheed Martin Corporation Completes Acquisition of Management Systems Designers Incorporated

Lockheed Martin Corporation announced that it has completed its acquisition of Management Systems Designers Incorporated (MSD), a Fairfax, Virginia-based provider of information technology (IT) and scientific solutions supporting government life science, national security, and other civil agency missions. The acquisition was originally announced December 21, 2006. Terms of the transaction were not disclosed.



Competition

Vs. Industry and Benchmark8

The below graph represents $100 invested Dec 31, 2001 (through Dec 31 ’06)



The S&P Aerospace & Defense Index comprises The Boeing Company, General Dynamics Corporation, Goodrich Corporation, Honeywell International Inc., L3 Communications, Lockheed Martin Corporation, Northrop Grumman Corporation, Raytheon Company, Rockwell Collins, Inc. and United Technologies Corporation.


Vs. Peers… 1-Year

2-year


And just because I thought it was interesting…



Since ‘83





 

LMT

BA

NOC

RTN

Industry

Market Cap:

44.48B

75.44B

27.97B

27.64B

1.03B

Employ­ees:

140,000

154,000

122,200

71,351

1.12K

Qtrly Rev Growth (yoy):

15.50%

12.10%

6.70%

9.00%

13.40%

Revenue (ttm):

41.86B

66.45B

31.24B

21.01B

540.65M

Gross Margin (ttm):

11.08%

19.44%

19.20%

18.91%

24.53%

EBITDA (ttm):

4.83B

6.81B

3.68B

2.47B

78.54M

Oper Margins (ttm):

9.65%

7.97%

9.51%

9.99%

10.18%

Net Income (ttm):

2.96B

4.01B

1.80B

1.23B

14.28M

EPS (ttm):

6.888

5.205

5.071

5.245

0.79

P/E (ttm):

15.71

18.7

16.3

12.05

23.99

PEG (5 yr expected):

1.36

1.3

1.24

1.4

1.36

P/S (ttm):

1.07

1.13

0.89

1.33

1.3

ROE (ttm)

38.2

46.02

10.33

10.42

17.7

D/E (mrq)

0.59

1.339

0.24

0.24

0.67

 













 

BA = Boeing Co.













 

NOC = Northrop Grumman Corp.










 

RTN = Raytheon Co.













 

Industry = Aerospace/Defense Products & Services

 

 


Price/Earnings = 15.71

The TTM (Trailing Twelve Month) Price/Earnings (P/E) ratio shows how much you pay for every dollar of earnings the company makes. It is calculated by dividing the price per share by earnings per share. The lower the P/E, the less you have to pay for the stock, relative to what you can expect to earn from it. LMT has a lower than the industry and two of their competitors.


Price/Earnings to Growth (PEG) = 1.36

PEG is a widely used indicator of a stock's potential value. It is favored by many over the price/earnings ratio because it also accounts for growth. Similar to the P/E ratio, a lower PEG means that the stock is more undervalued. LMT has a PEG ratio on par with industry and higher than two of it’s competitors. Backing out of the equation, LMT’s assumed EPS growth = 11.55% (Yahoo!).


Return on Equity (ROE) = 38.2%

The Return on Equity (ROE) percentage measures the rate of return on the ownership interest of the common stock owners. It is calculated by dividing Net Profits by Equity. It measures a firm's efficiency at generating profits from every dollar of net assets, and shows how well a company uses investment dollars to generate earnings growth. LMT has a ROE higher than the industry and two of its competitors.


Total Debt/Equity = 0.59

This indication of financial leverage measures the extent of a firm’s capital that is provided by lenders. This value computes the proportion of a company's debt compared to its available capital. By using this ratio, investors can identify the amount of leverage utilized by a specific company and compare it to others to help analyze the company's risk exposure. If a lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing. Generally, companies who finance a greater portion of their capital via debt (higher %) are considered riskier than those with lower leverage ratios. LMT has a D/E lower than the industry and one of its competitors.


Margins

Lockheed is performing better than the industry and most of it’s competitors in almost all areas except margins.

Profits and margins may vary materially depending on the types of long-term contracts undertaken. There are two types of contracts that affect margins: cost reimbursable and fixed-price contracts. Cost reimbursable contracts generally have lower profit margins than fixed-price contracts. Production contracts are mainly fixed-price contracts, and developmental contracts are generally cost reimbursable contracts. Under cost reimbursable contracts, subject to a contract-ceiling amount in certain cases, they are reimbursed for allowable costs and paid a fee, which may be fixed or performance based. However, if costs exceed the contract ceiling or are not allowable under the provisions of the contract or applicable regulations, they may not be able to obtain reimbursement for all such costs and may have our fees reduced or eliminated.9

I tried to find how many of each type they entered into, but could not find anything. My only assumption is that they entered into more cost reimbursable contracts over the trailing twelve months.



Buffet’s Owner Earnings Model

I used Warren Buffet’s Owners Earnings Valuation Model. This model required four inputs: discount rate (K), 5-year first stage growth rate, second stage perpetual growth rate and number of shares. I derived the discount rate using the CAPM equation. I used an average market return of 10.23% and the 90-day T-bill rate (risk-free rate) of 4.05% (Bloomberg). This gave a market risk premium of 6.18%. For the first stage growth, I took assumed the average of the analysts’ estimates as high estimates.



Growth Rate

Analysts’ Growth Rates










1-yr

5-yr

Yahoo

5.10%

11.56%

MSN

5.40%

9.90%

Reuters

7.28%

10.27%

S&P

5.00%

NA

I assumed analysts’ growth rates to be high at 10 to 12 percent. In this case, I believe 8% first stage growth is both reasonable and conservative.
For the Beta (β), I used three methods: an average three sources (Yahoo!, MSN, and Reuters), the industry average, and one between the two. From here, I ran a stress test on the varying betas and growth rates.

Average Beta (average from sources)

I found very low betas (some negative) across sources. I took an average of the three positive betas (Yahoo!= .3, MSN=.16, Reuters=.153).


β = .204; CAPM = Rf + β*(RM-Rf)

= 4.05% + 0.204*(10.23%-4.05%)

= 5.31%


K=5.31%

 

 

 

 

 

 

Growth

 

1st Stage

2nd Stage




4%

6%

8%

10%

12%

2%

188.29

210.46

234.96

262

291.8

3%

247.33

276.65

309.00

344.66

383.91

4%

396.32

443.68

495.86

553.26

616.33


Industry Beta10

β = .92; CAPM = Rf + β*(RM-Rf)

= 4.05% + 0.92*(10.23%-4.05%)

= 9.74%




K=9.74%

 

 

 

 

 

 

Growth

 

1st Stage

2nd Stage




4%

6%

8%

10%

12%

2%

84.62

94.01

104.4

115.9

128.62

3%

90.62

100.73

111.92

124.3

137.97

4%

98.7

109.79

122.06

135.62

150.59

Under the first beta, every growth rate considered shows that the stock is undervalued. Using the industry beta, about half of the results show the stock being undervalued. I consider the betas to be the two extremes. I typically think an average of betas across several sources is sufficient, but in this case, the results don’t seem realistic. However, I don’t think the Industry average beta is a good reflection of the company’s beta. The company will not be as volatile as the industry given its size and age. I believe the beta is somewhere between the two. The following model beta is derived from a mean of the two above betas.
Between Beta

β = .562; CAPM = Rf + β*(RM-Rf)

= 4.05% + 0.562*(10.23%-4.05%)

= 7.52%



K=7.52%

 

 

 

 

 

 

Growth

 

1st Stage

2nd Stage




4%

6%

8%

10%

12%

2%

115.66

128.91

143.57

159.78

177.69

3%

130.67

145.74

162.40

180.80

201.11

4%

154.20

172.12

191.91

213.75

237.82

I consider this estimated beta to be more realistic than the other two. With this, the stock appears to be undervalued in even the most conservative scenario.

I also ran a model, with this between beta, assuming a declining first stage growth rate of -1% a year, each year, for the five-year period (i.e. if I started with an 8% first stage, it would be 3% for the fifth period).



K=7.52%

 

 

 

 

 

 

Growth

 

1st Stage (declining)

2nd Stage




4%

6%

8%

10%

12%

2%

102.65

114.49

127.61

142.14

158.21

3%

115.61

129.06

143.95

160.43

178.65

4%

135.93

151.90

169.58

189.11

210.68

With the announcement to cutback defense spending, I thought this model would be appropriate. As you can see, the only time the stock appears overvalued is at a first stage declining growth of 4% (-1% growth for the fifth year) and a 2% terminal growth after that. All other growth rates show the stock being undervalued.

3rd Quarter Earnings Announcement

• Third quarter earnings per share up 23% to $1.80; Year-to-date earnings per share up 26% to $5.21

• Third quarter net earnings up 22% to $766 million; Year-to-date net earnings up 24% to $2.2 billion

• Third quarter net sales up 16% to $11.1 billion; Year-to-date net sales up 8% to $31.0 billion

• Cash from operations of $935 million for the quarter; $3.8 billion year-to-date

• Increasing outlook for 2007 earnings per share ($0.05/sh increase to $6.70-$6.85) and providing initial 2008 financial outlook (expect increase of 8% EPS from 2007)

• Operating margins increase for all business segments except IS&GS (down 0.3%)

• Aeronautics is expected to have continued decline in sales (~$0.5B in 2008)

• IS&GS expected to increase 10% YOY in 2008

• Electronic Systems expected to increase performance in all areas of the business segment



Recommendation

The Aerospace and Defense Industry is one of the few industries in the Industrial Goods sector that I found to be attractive. Within the Aerospace and Defense industry, defense accounts for 92.1% of the market value, and the U.S. accounts for 54.7% of the industry’s global market at the end of 2006.11 Even though the U.S. defense spending is expected to decline, I still believe this company has good potential. Lockheed Martin has several good things going for them. First off, the company is well diversified, with no more than 30% of sales coming from one segment of business. The stock price has performed well historically and future projections seem promising. They have attractive valuation ratios against their competitors and the industry. They appear to be undervalued after running the Buffet Model, even after a declining growth factor. Also, with five contracts successfully awarded this year and an expected backlog of $75 billion by year-end, the company appears to have positive outlook for the future.


I recommend to BUY 395 shares = $43,497.40 (~3% of total fund).
Stop Loss price = $95.00

Risk to Capital = (Current share price – Stop Loss price) * Shares / IFM Total Value

= (110.12 – 95.00) * 391 / 1,446,549.69

= 0.412% or $5,911.81



Appendix


Warren Buffett Way Owners' Earnings Discount Model

assuming discount rate (k) of

7.52%







Owner Earnings in 2006




Net Income

$ 2,529,000,000.00

Depreciation

$ 600,000,000.00

Amortization

$ 164,000,000.00

Capital Expenditures

$ (893,000,000.00)

Owner Earnings

$ 2,400,000,000.00










Year

 

2006

Prior Year Owner Earnings

$ 2,400,000,000.0

First Stage Growth Rate (add)

8.0%

Owner Earnings

$ 2,592,000,000.0

Discounted Value per annum

$2,592,000,000.0







Sum of present value of owner earnings

$24,204,582,171.6







Residual Value




Owner Earnings in year 10

$ 3,306,621,636.9

Second Stage Growth Rate (g) (add)

3.00%

Owner Earnings in year 11

$ 3,405,820,286.0

Capitalization rate (k-g)

4.52%

Value at end of year 10

$ 75,280,222,244.10







Present Value of Residual

$36,443,417,503.25

Intrinsic Value of Company

$60,647,999,674.85







Shares outstanding assuming dilution

421300000







Intrinsic Value per share

$143.95



2 2006 Annual Report

3 2006 Annual Report

4 2006 Annual Report

5 2006 Annual Report

6 Reuters

7 Boxell, James and Daniel Pimlott. New Weapons strategy correct says Lockheed. Financial Times. April 25, 2007

8 2006 Annual Report

9 2006 Annual Report

10 Value Line database: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/Betas.html

11 Datamonitor





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