Morningstar - Q1 2021 - 55

In a Prime Position
Lockheed Martin shares offer upside despite slowing
defense spending.
BEST IDEAS: EQUITY

Burkett Huey

Lockheed Martin LMT

This article is adapted from a Morningstar equity research report dated
Dec. 23, 2020.

Stats 12/31/2020

We view Lockheed Martin LMT as the highest-quality defense prime contractor
due to its prime position on highly prioritized programs, particularly the F-35,
as well as the company's portfolio positioning toward areas of secular
spending growth, especially missile-related and space technologies. The three
biggest stock-specific growth opportunities we see for Lockheed Martin are
F-35 sustainment, a large potential contract for the Future Vertical Lift program,
and hypersonic missiles and missile defense programs.
The defense budget and the allocation of the budget is a political process,
which is inherently difficult to predict. Therefore, we favor companies
with tangible growth profiles through a steady stream of contract wins, ideally
to contracts that are fulfilled over decades. Thankfully for defense investors,
many programs are procured and sustained over decades. For example,
the F-35, which accounts for about 30% of Lockheed's revenue, will be
sustained through 2070. Regulated margins, mature markets, customer-paid
research and development, and long-term revenue visibility allow the defense
primes to deliver a lot of cash to shareholders, which we view positively
because we don't see substantial growth in this industry.
Defense primes are implicitly a play on the defense budget, which we think is
ultimately a function of both a nation's wealth and a nation's perception of
danger. As the U.S. budget is looking increasingly bloated with pandemic relief,
we're expecting a near-term slowdown in defense spending to flat or even
negative growth. However, we think that contractors will be able to continue
growing due to sizable backlogs and expect that defense budget growth
is likely to return. We recognize there is substantial political uncertainty in the
budget, but we think that it will be difficult to materially decrease the defense
budget without sweeping political change. We continue to think that the
Department of Defense's increasing focus on great powers competition is a
long-term tailwind for the contractors.
The market's legitimate concern that substantial fiscal stimulus in 2020 will
stymie medium-term defense spending growth creates an opportunity for
investors. We anticipate that Lockheed can continue growing organic revenue
at a low mid-single-digit pace despite a slowing spending environment.
Lockheed's position as the highest-quality contractor should give investors

Morningstar Rating
QQQQ

Sector
p Industrials

Industry
Aerospace & Defense

Price
$354.98

Fair Value Estimate
$433.00

Uncertainty
Medium

Economic Moat
Wide

Capital Allocation
Standard

Market Cap
$99.32 Billion

Price/Fair Value 12/31/2020

Fair Value Estimate Per Share

$500
433.00
400
354.98

Month-End Closing Price

300
200

01/2018

01/2019

01/2020

more confidence in its ability to continue growing despite a slowing
budgetary environment.
After Lockheed's Dec. 20 announcement that it would acquire Aerojet
Rocketdyne, we are maintaining our $433 per share fair value estimate for the
firm. Our fair value implies a price/2021 earnings multiple of 16.6 times and
an enterprise value/2021 EBITDA multiple of 11.6 times. We think top-line
growth will slow from the highs of 2018 -19, averaging roughly 5.7% from 2020
to 2024. We think that aeronautics and missiles and fire control are the
big growth drivers, due to peaking F-35 deliveries, growing F-35 sustainment
revenue, and hypersonic missile development. We think the rotary and mission
systems will grow slower than the rest of the portfolio, due to slowing
helicopter demand (partially offset by the potential Future Vertical Lift contract).
The Aerojet Rocketdyne acquisition is likely to buoy growth in a slowing
spending environment. K
Burkett Huey is an equity analyst with Morningstar Research Services LLC.

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Morningstar - Q1 2021

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