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In my mind, any company involved with the production of the SR-71 Blackbird spy plane should carry a permanent buy rating. But for those stock investors looking for a better argument than that, TheStreet.com Ratings team has combed through the fundamentals of
to determine if its shares hold investment value in the current recessionary-depressionary environment.
Our models rate Lockheed an A, a grade that equates to a buy rating. The company is a world leader in aerospace and defense, second only to
in revenue -- $41 billion vs. $66 billion. However that's where the comparisons end, as Boeing's dependence on the commercial aviation market, i.e. the airline industry, has driven its shares down 46% year to date. Lockheed has fallen only 14% year to date.
The market is pricing Lockheed more favorably due to its role in national defense and the government contracts that flow from that position. Lockheed may have more in common with smaller rivals
; however, the shares of both these companies are down significantly this year. Northrop sports has tumbled 43% YTD, and General Dynamics has declined 31%. The market is clearly favoring Lockheed in this space.
The basic premise for getting behind Lockheed's stock rests with the long-term government contracts that the company can rely on over the coming years for revenue. Unlike commercial creditors, the accounts receivable from the U.S. government of $3.6 billion are going to be paid. Add in a another $1.3 billion in receivables from commercial and foreign governments, and receivables total $4.9 billion. Foreign governments are also unlikely to default on their payments to Lockheed. So the certainty of receivables collection is a strength.
The company earned net income of $3 billion in 2007, which equated to $7.29 a share -- up 23% from 2006. For 2008, the company looks set to continue its strong performance, generating GAAP earnings per share of $2.15 in the second quarter 2008, compared with $1.82 last year.
However, the question going forward is whether Washington and foreign governments will cut back on military spending amidst burgeoning deficits and the recent economic turmoil that's likely to constrain budgets. It is likely that defense spending will be cut, but the extent to which budgets are reduced may not be as great as suspected.
National defense is likely to be a priority for the U.S. and other foreign governments since history has shown that times of great global economic instability often have led to increased destabilization in world order. The maintenance of U.S. military prowess and that of her allies may remain key and save it from cuts at budget time.
But precedent does suggest that Lockheed will face challenges with a weakened economy as it did in 2000 and 2001, when EPS fell into negative territory and the company's share price fell to around $15. Its stock price, however, did recover after the events of Sept. 11, 2001, and the Bush administration's military response. Lockheed's net earnings increased six-fold, from $500 million in 2002 to $3 billion in 2007.
This growth resulted in the company's return on equity (ROE) increasing to 30% over the past two years; however, the long-term average ROE for Lockheed is only around 13%, and given its smaller equity base, as described below, this suggests the company is not a stellar performer in relation to the consistency and size of its earnings. It operates with thin average margins of 7% for gross and operating margins and 3% for net -- to be expected when tending for large government projects.
Since 1996, the company has maintained a remarkably stable asset base, with total assets remaining at roughly $29 billion for the past 12 years. The company's use of leverage to fund this level of assets is currently acceptable around 66 cents of liabilities and 24 cents of equity being used to fund every dollar of assets (a 66:24 ratio). However, the company has used 70:30 and 80:20 ratios in the past, which are well above average debt levels, especially going into a downturn. So management has done the company a favor by reducing its leverage at this critical time in the economy.
Lockheed's share price has pulled back from its 52-week high of $120 and now trades around $95. Adjusting EPS downward for the economic situation and using basic discount cashflow techniques results in a valuation range of $55 to $70 for this stock. The price-to-earnings ratio of just 12.5 reflects the stagnant asset base and limited growth potential of this stock; however, at a time of economic contraction, this is appealing. It is the stability of the government contracts that play in this company's favor.
Lockheed's book value is currently around $23, up from the $15-$17 range it maintained for nearly 14 years, from 1993 to 2006. Using a book value of $23, a price target of $55 suggests a valuation of 2.5 times book, which is not too bad.
Keep Lockheed in mind for a long-term buy and hold. If you can get it cheaper than $55, all the better. We are going into a serious correction that could last several years, so you have plenty of time to assess and make a decision on this stock.
Sam Patel, CFA, is the manager of mutual fund research for the TheStreet.com Ratings.
In keeping with TSC's Investment Policy, employees of TheStreet.com Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department, and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published.
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