Lockheed Martin’s (NYSE:LMT) fourth-quarter earnings miss may not be the toughest challenge it faces in 2013 while a spate of problems with its F-35 Joint Strike Fighter program continues to attract the wrong kind of attention. Still, over the longer haul, the defense and aerospace giant’s aggressive cost-control strategy and strong backlog should help it weather even the roughest turbulence.
LMT on Thursday reported a 17% drop in fourth-quarter earnings from the same quarter in 2011. It reported income of $569 million ($1.73 a share) on revenue of $12.1 billion, missing analysts’ expectations for EPS of $1.82. LMT shares fell about 3% on Thursday in response to the earnings news.
But Lockheed Martin remains optimistic about 2013 — it believes it can cut costs aggressively enough this year to deliver a full-year EPS of $8.80 to $9.10 for fiscal 2013. It expects cash from operations to hit at least $4 billion. Another bright spot is the deal it cut last month with the Pentagon for a fifth lot of 22 additional F-35s for $107 million each.
The new contract, which will be a strong contributor to its backlog, which also includes three Marine Corps versions of the F-35 that can take off and land vertically, as well as seven U.S. Navy variants, which can be deployed on carriers.
But therein lies the rub. With a history of delays and cost overruns — not to mention a $400 billion program price tag — the F-35 is bound to be a target for any additional Pentagon budget cuts that land this year. Also, former Nebraska Sen. Chuck Hagel, President Obama’s nominee for defense secretary, is on record saying the Pentagon budget is “bloated” and needs to be “scaled back.”
It doesn’t help matters that the Pentagon’s annual Director of Operational Test Evaluation (DOT&E) report found evidence that the F-35 is not ready for prime time. The report details serious shortcomings in the jet — problems LMT contends have been fixed.
Ironically, the Pentagon report contends that the Lightning II is vulnerable to, of all things, lightning. Additionally, removal of two safety systems to meet weight specifications increase the risk that the plane will explode if hit by enemy fire — not a good characteristic in a fighter jet. To make matters worse, Defense grounded a Marine Corps variant on Jan. 18 after an in-flight problem with the jet’s fuel system. The grounding affects only F35s that can take off and land vertically.
The performance issues are a big black eye for the delay-prone program. LMT did not dispute the findings of the DOT&E report, but F-35 Business Development Director Steve O’ Bryan characterized them to FlightGlobal as “known items, normal discoveries.” He contends that the company is on track to “finish development in 2016.”
Bottom Line: There’s no way to parse it: New F-35 problems are bad news for Lockheed Martin, which faces significant threats from planned Defense cuts. It can ill afford additional bad PR because it can chill international sales of the jet as well as delay Pentagon deliveries. This year, LMT counts on receiving so-called “long lead funding” for 48 F-35 aircraft in lot eight of the program — that breaks down to 29 domestic jets and 19 for international customers.
“Sequestration” is a risk as well. Lockheed believes the federal government will be able to avert an additional $500 billion in the mandatory cuts that would take effect automatically if lawmakers can’t get a budget deal done by the now March 1 deadline. Lockheed’s new CEO Marilyn Hewson, who took the helm on Jan. 1, said LMT could cut enough costs this year to exceed earnings expectations.
Despite the headwinds facing Lockheed Martin, I think it’s a good time to hold. The company has a strong track record of cost control, plans to end 2013 with an order backlog of $80 billion and other high-performing units — including the Dragon family of intelligence surveillance and reconnaissance (ISR) offerings — look good.
The stock’s 4.8% current dividend yield can’t be ignored, either. With a price-to-earnings growth (PEG) ratio of 2.44 and a forward P/E of nearly 12, LMT looks a little overvalued now, but I think the stock could slip into a more affordable altitude in the next couple of weeks.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.