By Calvin Biesecker
Lockheed Martin [LMT] yesterday reported a slight gain in net income in its third quarter that beat consensus expectations due to a tax benefit, but the nation’s top defense contractor said profits would be lower in 2010.
A number of factors are contributing to the lower profit expectations, such as higher pension expenses and changing security priorities in the Obama administration.
Recent program cancellations by the Obama administration such as the VH-71 presidential helicopter program, next-generation satellite communications systems, and the early termination of the F-22 fighter “have resulted in a loss of revenue and profitability that cannot be made up near-term,” Bob Stevens, Lockheed Martin’s chairman, president and CEO, said on yesterday’s earnings call.
The company increased its profit outlook for 2009 based on the tax benefit and a boost in non-operating income, but profit expectations for next year are down due to lower segment profits and higher pension expenses. The 2010 outlook doesn’t assume that Congress will extend the research and development tax credit expiring at the end of this year, which would mitigate some of the expected decline in profits.
JP Morgan defense analyst Joseph Nadol said in a note to clients yesterday that Lockheed Martin’s “weak” 2010 guidance is below his “well below-consensus estimate.” However, he said that the company doesn’t factor in future share repurchases, which would bolster earnings per share (EPS). Given the bad news in the form of a weak outlook combined with likely share repurchases, Nadol sees this as a buying opportunity for Lockheed Martin’s stock.
In trading yesterday Lockheed Martin’s stock price fell $5, or more than 6 percent, to close at $71.99.
Overall, net income rose 2 percent to $797 million ($2.07 EPS) compared to $782 million ($1.92 EPS) a year ago, topping analysts’ estimates by 14 cents EPS. The results included a negative $113 million pension adjustment and an unusual $58 million tax benefit, which combined decreased net earnings by $15 million (4 cents EPS).
Sales in the quarter climbed nearly 5 percent to $11.1 billion compared to $10.6 billion a year ago.
Results were mixed across the company’s various segments–the Aeronautics and Electronic Systems segments offering solid top and bottom line growth. The F-35 Joint Strike Fighter, C-130J transport aircraft, P-3 anti-submarine plane and other advanced aircraft development efforts drove results at Aeronautics.
Meanwhile, performance issues combined with contract protests and delays in program starts stemming from the change in presidential administrations continued to plague results at the Information Systems and Global Services (IS&GS) segment. Sales edged up a percent but operating profits declined 9 percent due to performance on certain global defense programs and a reduction in favorable contract performance adjustments compared to 2008.
Lockheed Martin’s Space Systems segment saw profits slip 3 percent due to the lack of favorable performance adjustments on government satellite programs compared to 2008 and fewer profits in defense missile systems despite a 9 percent increase in segment sales.
For all of 2009, earnings are expected to be between $7.40 and $7.60 EPS. The previous outlook was between $7.15 and $7.35.
Sales next year are expected to rise nearly 4 percent to between $46.3 billion and $47.3 billion. Operating earnings are expected to be between $4 billion and $4.1 billion and EPS between $7.05 and $7.25.
Beyond 2010, Lockheed Martin sees sales growth of around 5 percent or better, driven by the ramp-up in the F-35 program as it transitions to production for the United States and allied military customers. In addition, deliveries of F-16 fighters and C-130Js will increase and the company believes it is well positioned for a downselect next year on the Navy’s Littoral Combat Ship program, Stevens said. He also said the administration’s changing missile defense priorities, particularly in Europe, favor the company’s Aegis combat system.
Stevens also mentioned other opportunities including adjacent military markets for military vehicles, the non-defense federal information technology budget, cyber security, logistics and supply chain management, and better energy resource utilization all as areas providing growth opportunities for Lockheed Martin.
The company’s growth forecast exceeds what it expects will be the increases in the investment portions of future defense budgets. The defense investment accounts are projected to rise between 2 and 3 percent, but could be less, Stevens said. The potentially weaker defense numbers are factored into the company’s out-year revenue expectations, he added.
Despite the recent program cancellations, Stevens said the clarity is much better for defense spending, which gives the company confidence in its longer-term forecasting. Administration and congressional support for the F-35 program is one example of this clarity, but so is Defense Secretary Gates’ emphasis on moving forward with programs that represent a “75 percent solution” and can be obtained less expensively than the “99 percent” solution that takes longer to acquire and costs more, Stevens said.
This strategy favors companies with established backlogs, which will allow for improvements and changes to be spiraled in over time, Stevens said.
Lockheed Martin’s backlog at the end of the quarter was $76.4 billion, down $4.5 billion since the start of the year. The decline factors in all program terminations, the company said.
Stevens said that to attain its goals in a fiscally constrained environment, Lockheed Martin will have to “improve our focus and step up our game.” With this in mind Stevens said he reestablished the position of president and chief operating officer and asked Chris Kubasik to fill these roles. Kubasik currently heads the Electronic Systems segment.