“That was some of the best flying I’ve seen to date — right up to the part where you got killed.”
– Top Gun
Lockheed Martin’s (NYSE:LMT) F-35 Lightning II Joint Strike Fighter may be Tom Cruise’s co-star in the upcoming Top Gun 2, but fame isn’t enough to ensure fortune for an embattled program that has been plagued by delays and cost overruns.
LMT’s F-35, in which Northrop Grumman (NYSE:NOC) and U.K.-based BAE Systems are major partners, is designed to provide advanced stealth, agility and maneuverability. The program eventually aims to replace existing fighters such as General Dynamics’ (NYSE:GD) F-16, Boeing’s (NYSE:BA) F/A 18, Northrop Grumman’s EA-6B and Boeing’s AV8-B Harrier (which can take off and land vertically like a helicopter).
But extensive delays, cost overruns and a White House directive to slash defense spending have combined to create a perfect storm for the Lightning II — and a potential maelstrom for LMT’s earnings. The FY 2013 defense budget calls for delaying production on 179 F-35s scheduled for delivery over the next five years. That amounts to $15.6 billion Lockheed Martin won’t be seeing anytime soon.
Vice Admiral David Venlet, who heads the Pentagon’s F-35’s program, has been openly critical of the aircraft — particularly the assumption that it could be built while testing was still under way. “Fundamentally, that was a miscalculation,” Venlet told AOL Defense in an interview last December.
While Lockheed Martin has argued that past problems have been resolved and that now is the time to speed up production, Venlet is opting for a more cautious approach. One example is in the area of fatigue testing, where the need to redesign and install parts in jets already built could add “$3 million to $5 million to the cost of each plane.”
It didn’t help the F-35’s case that last week’s long-awaited training flight at Eglin Air Force Base in Florida was cut short by three loose fasteners on the plane that caused a fuel leak 20 minutes into the flight. The aircraft landed safely without incident.
While the U.S. is the primary F-35 customer and is ponying up the lion’s share of the program’s cost, eight partner nations (Italy, Canada, Turkey, Australia, Norway, Denmark, the Netherlands and the U.K.) have committed $4.4 billion in development costs. Last month, Italy cut its planned order of the jets from 131 to 90 as part of new defense cuts.
Potentially more alarming news for LMT’s program came from Japan, which indicated it might cancel the 42 F-35 joint-strike fighters it has ordered if price overruns and delivery delays continue. Japan expects to pay about $123 million per fighter, with its first four aircraft to be delivered in 2017. Venlet, however, assured LMT and the industry that Japan’s order is still “firm.”
Last week, Pentagon officials scrambled to reaffirm the U.S. military’s commitment to the $380 billion program, which has lifetime sustainment costs of an estimated $1 trillion. Lieutenant General Herbert Carlisle, the Air Force’s deputy chief of staff for operations, said his service will delay operational use of the F-35 beyond the original 2016 target.
Still, in a meeting with officials from Lockheed Martin and the eight partner nations last week, Venlet conceded that the Pentagon’s delay of the 179 orders will raise the price per aircraft in the short run. However, he cautioned LMT to continue to drive down production costs as much as possible.
But if life has dealt the F-35 a bad hand, perhaps art will be kinder. Earlier this month, LMT’s F-35 program manager, Tom Burbage, told an aerospace industry luncheon that the F-35 will be Tom Cruise’s co-star in the upcoming Top Gun 2. While Hollywood insiders are mum about the plot, Burbage says: “[Cruise’s character] will come back as an F-35 test pilot.” The original film was a virtual tribute to the Grumman F-14 Tomcat.
The bottom line: The F-35 is far from dead. Even the U.K. may decide to buy the complex Marine Corps F-35B variant. But the program will continue to face headwinds from global defense-budget cuts and pricing pressure as well as the myriad challenges of production delays and glitches.
This is a huge program for LMT (and, to a lesser degree, for NOC and BAE), so continued delays, overruns and missteps could have buyers looking longingly at Boeing’s less stealthy but more affordable (less than $60 million each) F/A-18.
Lockheed Martin’s shares, currently trading around $90, are not in the danger zone yet. Shares are up 34% over their 52-week low last August. And with a market cap of $28.5 billion, LMT a current dividend yield of nearly 4%, making it a wise play to hold now.
Still, while the company’s fundamentals are sound, it would be prudent to wait until the dust settles on the F-35 before initiating a new position in the stock.
As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here.