Ticker: lmt sector: Industrials Industry

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.

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.

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.

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.

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.

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.

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.

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 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.

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

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.

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

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.

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

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

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.

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).

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.

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.

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.

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.

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.

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.

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.

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.

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.

2-year

And just because I thought it was interesting…

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.

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!).

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.

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.

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.

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.

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

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

= 5.31%

β = .92; CAPM = R_f + β*(R_M-R_f)

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

= 9.74%

β = .562; CAPM = R_f + β*(R_M-R_f)

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

= 7.52%

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).

• 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

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.

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