- Lockheed Martin's prime contractor role on the F-35, the largest weapon program in history, should deliver stable revenue for decades through procurement and sustainment.
- The National Defense Strategy prioritizes missile development and missile defense, which Lockheed excels in.
- Defense prime contractors operate in an acyclical business, which could offer some protection in a recession.
- Lockheed Martin depends on U.S. military funding for its sales, which is an inherently political and thus uncertain process. U.S. pandemic relief spending may crowd out future defense spending.
- There is a risk that upstarts like SpaceX will threaten incumbents' oligopoly in space contracts, such as space transportation programs and satellites.
- Lockheed Martin continues to face operational execution risk with regard to the F-35 program, which accounts for roughly 30% of sales. While costs have been managed recently, the program saw substantial cost overruns in development.
Morningstar Analyst Burkett Huey Says
We think Lockheed Martin’s LMT exposure to the F-35 fighter jet program, hypersonic missiles, and the militarization of space gives the company a massive revenue base with long-term growth prospects. The allocation of the defense budget is a political process, which is inherently difficult to predict. Therefore, we favor companies with tangible growth profiles through a steady stream of contract wins, ideally contracts that are fulfilled over decades. Thankfully for defense investors, many programs are procured and sustained over decades. For instance, the F-35, which accounts for about 30% of the company’s revenue, will be sustained through 2070. Regulated margins, mature markets, customer-paid research and development, and long-term revenue visibility allow the defense prime contractors to deliver a lot of cash to shareholders, which we view positively because we don’t see substantial growth in this industry.
Defense prime contractors are implicitly a play on the defense budget, which we think is ultimately a function of a nation’s wealth as well as a nation’s perception of danger. The fiscal stimulus used to support the U.S. economy during the COVID-19 pandemic dramatically increased the national debt, and higher debt levels are usually a forward indicator of fiscal austerity. But we expect a flattening, rather than declining, budgetary environment as we think heightened geopolitical tensions between great powers are likely to buoy spending despite a higher debt burden. We think that contractors will be able to continue growing despite a slowing macro environment, thanks to sizable backlogs and the National Defense Strategy’s increased focus on modernization, and we think that defense budget growth is likely to return to its long-term trend. We note that one of the most common budgetary compromises of the previous decade has been more nondefense spending for more defense spending.
The three biggest stock-specific growth opportunities we see for Lockheed Martin are F-35 sustainment, a large potential contract for the Future Vertical Lift helicopter program, and hypersonic missiles and missile defense programs.