Amid unprecedented geopolitical tensions, Lockheed Martin (LMT) has changed its trajectory for the rest of the decade. The company, heavily criticized as one over reliant on the slow growth of U.S. defense spending, finally has the chance to meaningfully diversify geographically and take advantage of deteriorating European relations. Let’s examine how Lockheed can make this jump and then sustain these demand levels long-term.
The Fight For Ukrainian Democracy
As Ukraine continues to fight tooth and nail for its sovereignty, Lockheed Martin’s equipment has been increasingly involved on the ground. With about 30% of solutions being used in the war, including:
- Javalin Missiles & Other Weapon Systems – Premier anti-armor defenses as well as precision missiles
- Command, Control, Communications, Computers, Intelligence, Surveillance and Reconnaissance (C4ISR) – Helping countries provide Ukraine with accurate information on potential attacks
- Maritime Support – Currently in a limited capacity but will become more prominent as Russians bombard port cities like Odesa through the Black Sea and the Sea of Azov
- Cyber – Digital infrastructure aid as they fall victim to constant Russian cyberattacks
The sudden spike in growth is likely to be reflected in Q1 2022, especially with the growing list of countries pledging support like:
- U.S. – $1B+ commitments along with publicly revealing the massive amounts of javelin missiles and intel Ukraine has requested, both of which have been quintessential in stopping the Russian advance
- U.K. – Naval commitments via their Naval Capabilities Enhanced Programme (NCEP) as well as anti-tank systems
- France – Providing digital weaponry and improving cybersecurity capabilities
- Canada – $400M in financial commitments and lethal weaponry for usage across the battlefield
- Netherland & Germany – Sending anti-tank defense systems
- Sweden, Belgium, Portugal, Greece, Romania, Spain, Czech Republic are also all sharing similar equipment and intelligence
With more and more countries releasing their military reserves to Ukraine, Lockheed Martin will likely benefit from the increased backlog as countries try to rapidly fill reserves in light of present circumstances. However, in order to extend this beyond FY 2022, global defense spending will have to remain at elevated levels, something that German chancellor Olaf Scholz has reaffirmed.
Lockheed’s two-pronged approach to growth begins with rising European tensions. Germany’s stark departure from their policy of not exporting weapons to conflict zones and raising defense spending to 2% of GDP marks a new dawn for Europe. The largest economy and great stabilizing force of Europe has set off a chain reaction with NATO nations that will also look to expand defense spending in the name of national security.
One area to watch is countries’ aircraft fleet upgrades – an area Lockheed has spent a significant amount of capital in. For example, in Germany specifically, the company can take advantage of its great relationship with the German Bundeswehr (army) and their need to replace an outdated fleet of 85 Tornado jets – a potential $6.72B+ contract.
What’s even more astounding is that this $6.72B is just a fraction of the total $113B Germany will spend on defense and the trillions of dollars that Europe as a whole might spend in the aftermath of Russia’s war with Ukraine. French President Emmanuel Macron reiterated this rhetoric in a striking TV address saying:
[Europe] cannot depend on others to defend us, whether on land, at sea, under the sea, in the air, in space or in cyberspace. In this respect, our European defence must take a new step forward.
and that in this changed era:
War in Europe no longer belongs in our history books or schoolbooks, it is here, before our eyes. Democracy is no longer considered an unquestionable system, it is questioned, before our eyes. Our freedom, that of our children, is no longer a given.
From this, it is clear that peace and diplomacy are off the table; Europe feels vulnerable and urgently wants to protect itself. Moreover, as talks about expediting NATO membership heats up, the number of interested nations – like Bosnia and Herzegovina, Georgia, Sweden, Finland, and Serbia – continues to grow. This would only mean more opportunity for Lockheed as NATO nations are required to spend a minimum of 2% of their GDP on defense.
Another aspect of their growth prospects is their innovational moat over competitors. Take Lockheed’s Automation and AI department that is developing an advanced logistical software called VCSi.
If we’ve learned anything from Russia’s botched invasion of Ukraine, they’ve been unable to transport key resources which have stagnated forces. Lockheed’s VSCi system alleviates these problems by arming militaries with immersive 3D Mapping tools, real-time data, and a vast map database that allows for interactive route planning and increased efficiency. Currently, the software is being used in the United States, Canada, and the UK, but look for the number of clients to increase as Europe prepares for the worst.
Even more than VSCi, cyber security has the potential to be one of Lockheed’s top products, especially with Russia and China’s continued cyberwarfare. Attacks in cyberspace are carried out through a framework dubbed as the ‘Cyber Kill Chain.’
To defend critical infrastructure, the company developed an ‘Intelligent Driven Defense’ which stops offensive maneuvers at every step during a cyber-attack. Even more important is making sure that members of the military, at all experience levels, understand how these operations work, which is why Lockheed has introduced a solution Henosis (Greek for unity). The unified platform uses a single interface that simplifies cyber intelligence missions and allows for the technology to be used by a wider range of military officials.
In addition to these innovations, the company has been ramping up its involvement in the next frontier of lethal weapons – hypersonic missiles. Considering that Russia and China are the only countries other than the U.S. to possess this weaponry, it is critical that the west act fast. Lockheed has been ramping up production for hypersonic technology, opening up a production facility in Alabama as part of a 151% increase in CapEx spend for their Missiles and Fire Control segment. These costs are warranted as they will likely result in higher revenues with European nations lining up for contracts to supply their military with these weapons.
Tensions in Europe offer Lockheed a chance to address one of the company’s greatest issues – geographic revenue diversification.
The company’s top two growth segments of Missiles and Fire Control at 12% and Rotary and Mission Systems at 6%…
also happen to be the two most concentrated in the US (not including space business because most revenues come from long-term contracts with NASA).
Over the next few quarters, as growth in US defense spending moderates, it will be offset by demand from the Russia-Ukraine war. However, if Lockheed wishes to sustain this low double-digit/high single-digit growth, it needs to meaningfully expand operations into Europe which is filled with nations looking to bolster their defenses.
Taking a look at the company through the lens of macroeconomic risk, it looks quite attractive.
Over the past 8 quarters, Lockheed has rapidly paid down debt as is shown through deleveraging from 3.68x to now just 1.07x – a far more investable balance sheet given the impending rise in interest rates.
When looking at inflation’s impact on the company, margins have avoided erosion, hovering between 13.4% – 13.6%. However, the 70 basis point decline from Q3 to Q4 2021 is a bit concerning as inflation rose the most during this period of time. Q1 2022 results should shed some more light on this and it should be a concern at top of mind for investors.
One thing shareholders don’t need to fret over is the dividend. With operating cash flow and free cash flow hitting record highs this past quarter, not only can Lockheed sustain their 12% dividend growth, but as demand booms, look for the company to get even more shareholder-friendly.
Additionally, the company can use excess cash for more R&D in hypersonic missile defense systems, something that Raytheon is a step ahead of them in, or advanced cyber security systems to keep up with China or Russia.
At North Post Research, we have recognized the importance of valuing companies not only by traditional metrics, but also by their Environmental, Social, and Governance (ESG) goals. In addition to our analysis, we will be adding a sustainability scorecard that grades the beliefs and initiatives of each company. Lockheed Martin’s sustainability policies can be found here. Its total average score was 8.67.
Although Lockheed’s progressive environmental goals are reflective of the company’s forward-thinking culture, results matter – and mediocre ones won’t cut it.
When compared to fellow competitor Northrop Grumman (NOC), it is being outpaced in every aspect. Since 2010, Lockheed has reduced its Scope 1 & 2 GHG carbon emissions by 38% from 1.27M metric tons to 790k; Northrop reduced its emissions by 44% in the same time frame from 730k (less than Lockheed’s current emissions) to now just 412k. The numbers are even more skewed as we look at water usage. Since 2016, Lockheed has increased its water usage by 14% while Northrop was able to decrease its usage by the same amount.
Even more, the company failed to meet 2 of its 3 critical environmental goals using a 2010 baseline.
These abysmal results lead to an abysmal score, however, with Lockheed launching a fresh set of 2025 goals, we will soon reevaluate our stance.
Lockheed Martin’s small business support and employee inclusivity practices are emblematic of a pure American company.
Its supplier support program has 4 critical parts:
- Supplier Diversity – Negotiate and award subcontracts to women, military, LGBTQ, disabled, and HUBZone-owned businesses through various small-business events.
- Supplier Ethics – 12-part suppliers ethics program that suppliers must undergo and then use to implement their own ethic programs, including writing their own code of business and supplier conduct
- Supplier Training – Helps small underserved businesses continue to grow through training and mentorship programs like the Supplier Training Excellence Program (STEP) or the Procurement Technical Assistance Program which builds connections with private and government contractors
- Supplier Cybersecurity – Work with Boeing (BA), Northrop Grumman, and Raytheon (RTX) as part of an industry-wide effort to evaluate and short up supplier cybersecurity and readiness in order to protect key supply chain inputs
In addition to their support of small businesses, the company gives back to the military community. Over 20% of employees are veterans or war-disabled, and the company has handed out over $700M in subcontracts to more than 750 military family-owned companies. Moreover, Lockheed is only boosting its talent pool by hiring those who have served on the battlefield as they can add their first-hand experiences to product innovations.
With the world undergoing an information security crisis, Lockheed’s esteemed management has taken steps to address this problem. Not only did the company meet each of its 2020 cybersecurity goals, but they have successfully launched programs like the Insider Threat Awareness Campaign that divert data loss and employee phishing issues. Moreover, Lockheed passed a Level 3 CMMC Mock Assessment, which means that one’s cybersecurity is sufficient enough for the Department of Defense to trust them with highly sensitive information.
Beyond this, Lockheed has an entire Sustainability Working Group, led by the SVP of Ethics, that helps to implement its sustainability agenda. Many projects and internal corporate decisions run through this group to ensure that major announcements are aligned with the shareholder and ESG principles the company is committed to. This checks and balances accountability system make us even more confident that Lockheed is doing its best for shareholders and the world.
Technological innovation, increased European defense spending, low debt, and inflation-proof … it’s the perfect way to weather geopolitical and market volatility. Investors should invest and forget with Lockheed Martin.