The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
NEW YORK (
is one of the world's largest defense contractors globally involved in the research, design, development, manufacturing, integration and service of advanced technology systems and products. The firm also provides a range of engineering, technical, logistical and information services to its clients globally. The U.S. government is the firm's largest customer and in 2010 accounted for about 84% of the firm's net sales.
Lockheed competes with a number of other government contractors such as
. Here, we look at some key trends affecting Lockheed Martin's equity value.
We recently launched coverage on our analysis of
Lockheed Martin with a $98 price target which represents nearly 40% upside from current market levels.
U.S. Debt Deal May Lead to Further Defense Cuts
The U.S. debt deal plans to cut government spending by $2.1 trillion over the next 10 years. This includes a planned cut of $350 billion in the U.S. defense budget. The projected cut through the debt deal is already in line (in fact $50 billion lower) with Obama's previous announcement of $400 billion in defense cuts for the next 12 years.
However, further defense cuts are possible when the so-called "Super Congress" meets. This group will determine where in the government the next $1.2 trillion in spending cuts will come from. For Lockheed Martin, this can translate to reduced government contracts and more stringent Federal procurement policies, both of which can hurt revenues and margins for its business.
U.S. Government Procurement Trends Show Stronger Preference for Services
From 2008 to 2010, the DoD (department of defense) placed stronger emphasis on procuring services over products. Spending on products had declined by 15% in the last 3 years while spending on services has increased by 7%.
In overall DoD contracting, services have grown at a faster pace than products. Barring any future military contingencies (such as the global war on terror), services are expected to grow at a higher rate than products. From the company's perspective as well, services have increasingly occupied a larger share of the overall company revenues, increasing from 17.6% in 2008 to 20.4% in 2010.
Increased Emphasis on Fixed-Price Contracts Can Impact Future Margins
As the largest defense contractor to the U.S. government, Lockheed Martin's business is dependent on government contracts for all its operating divisions. However, a 2009 directive by the Office of Management and Budget (OMB) aims to further migrate from cost-based to fixed-price based contracts, and we expect the company's US-based divisions to be subjected to higher risk as any cost over-runs would directly impact margins under a fixed-price contract (unlike a cost-reimbursement contract). This trend can significantly impact EBITDA margins of the company in future years.
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This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.