Lockheed has assembled an unmatched portfolio of capabilities in aerospace, precision strike systems, electronics, satellite and other goodies. Its flagship F35 multirole fighter and deadly Javelin missile are used to making headlines nowadays, but the breadth of the group's offering is just mind-boggling.
After five decades of active consolidation, the U.S. defense industry has now become an oligopoly, with Lockheed leading far ahead of its four domestic peers—General Dynamics, Boeing, Raytheon and Northrop—in terms of revenue.
However, the regulator has signaled that consolidation had reached its final stage when it called off Lockheed's attempted takeover of Aerojet Rocketdyne last year.
There is limited overlap between the five groups' portfolios, which leads to each of them specializing in certain systems and ensures a healthy competitive landscape. In particular, Lockheed and Boeing have now built unassailable moats in aerospace.
Higher margins and share buybacks
Not all oligopolies or duopolies are created equal—they do not necessarily guarantee sure profits. Boeing's woes with its civil aviation business is a testament to that. Its arch rival Airbus has fared better but is still unable to generate actual free cash-flows.
Those aren't a concern for Lockheed, which generates cash earnings as tangible as the accounting profits it reports over a full cycle. Growth is slow—from $47bn to $67bn over the last decade, i.e a compound annual rate of 3.6%—but operating earnings have doubled and earnings per share tripled from $7.5 to $23.
These gains result from higher margins and massive share buybacks—a hallmark of Lockheed's shareholder-friendly capital allocation policies. Over the 2011-2021 cycle, the group generated $45bn in free cash-flow—an amount perfectly reconcilable with its accounting earnings—entirely returned to shareholders via equal amounts of buybacks and dividends.
The $11bn spent on external growth—$9bn of which devoted to the acquisition of helicopter manufacturer Sikorsky in 2015—have been funded by debt and small share issues earlier in the decade.
The balance sheet carries $20bn in net long-term financial obligations—debt, pension plan and other commitments—against only $10bn in equity. Here is where investors may express variant perceptions on the soundness of Lockheed's capital allocation policies.
Some, in tune with management, would argue that visibility on the backlog of orders means that the business can be run without any solid equity buffer. Others will draw parallels to the misdeeds of Boeing—who adhered to a similar blueprint of massive share buybacks—and the disaster that followed, and may hence feel less comfortable. Defense spending is cyclical after all, and the United States' federal budget not exactly in the comfort zone.
Said buybacks at Lockheed were completed at an average price-earnings ratio of x17, i.e the average multiple investors placed on the shares during the 2011-2021 period—the lowest was x10 earnings, and the highest x25.
Value investors who demand sizable margins of safety would likely pass on that one, waiting for shares to trade at the x10 earnings floor—as they did a decade ago when president Obama announced progressive withdrawals from the Middle East.
Momentum-driven investors, for their part, may find the current set-up of shares trading at x15 forward earnings coupled with rising geopolitical tensions totally irresistible. A troubled decade starts and it's unlikely that Uncle Sam intends to disarm—rather the opposite.
In addition, after much criticisms the F35 program is finally delivering on its promises with a record influx of orders and mega export contracts with the UK, Germany, Poland, the UAE, Australia and Norway. Beyond deliveries, this global procurement guarantees decades of business related to spare parts, upgrades, weapons systems and maintenance.