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Lockheed in the Twilight of 2011-12

Zacks Equity Research

Lockheed Martin Corporation (LMT'>LMT) had mixed fortunes during the cross over from fiscal 2011 to 2012. The defense behemoth operates in an industry characterized by high level of competition and is subject to fluctuations in defense spending.

At the fag end of 2011, Uncle Sam, in a clever move, has approved the first Foreign Military Sale of the Terminal High Altitude Area Defense (“THAAD”) Weapon System to the United Arab Emirates. The sale comes on the heel of U.S. Defense Secretary Leon Panetta’s promise that the U.S. will continue to have a “robust” military presence in the Middle East even as it withdraws from Iraq.

In lieu of the growing Iranian expertise in missiles, THAAD, designed to shoot down short, medium, and intermediate ballistic missiles, will add stability to the region. As a result, Lockheed Martin received a contract totaling $1.96 billion to produce the THAAD Weapon System for the United Arab Emirates. 

The Middle East equation comes as a multi-billion new-year bonanza for the defense primes in general and Lockheed Martin in particular. Lockheed Martin is the prime contractor for the project aided by the likes of  Raytheon Company (RTN'>RTN), The Boeing Company (NYSE:BA - News), GenCorp Inc. (GY'>GY), and Honeywell International Inc. (NYSE:HON - News).

For Lockheed Martin, the THAAD contract will be a consolation for the two big jolts it suffered at the twilight of 2011-2012. Arch-rivals Boeing and Northrop Grumman Corporation (NOC'>NOC), at the fag-end of 2011, beat Lockheed to win a $3.48 billion, seven-year contract for the primary developer of the U.S. shield against intercontinental ballistic missiles.

The wound for Lockheed was not sealed at this with a meaner Obama, aghast at a fragile economy, voter discontent in popularity surveys and a national unemployment rate of 8.6%, is bent on snipping the largest Lockheed program, the F-35. The President ended 2011 with signing into law a $662 billion defense spending plan (National Defense Authorization Act for Fiscal Year 2012) and stipulating cutbacks in defense programs in general and the F-35 program in particular.

The sanctioned amount is $27 billion less than what was originally sought and $43 billion less year over year. In the bill, the administration gave clear directives to the Pentagon to change the program to fixed-price from the earlier cost-reimbursable. This would not be welcome news for Lockheed which is witnessing a series of cost overruns and delays in the Pentagon’s largest program, the F-35.   

Lockheed Martin is the largest U.S. defense contractor with a platform-centric focus that guarantees a steady inflow of follow-on orders from a leveraged presence in the Army, Air Force, Navy and IT programs. Over the longer run, we expect the company to register a stable performance driven by a leveraged presence in various branches of the defense forces.

We also expect shareholder return to continue to be shored up by the company’s focus on debt repayment, its ongoing share repurchase program and the incremental dividend.

Looking backward in 2011 the U.S. GDP growth improved steadily with growth of 2.0% in third quarter, up from 1.3% in second quarter and 0.4% in first quarter. In keeping with the momentum, we expect the final quarter to clock GDP growth of 3%.

However, after that in first quarter 2012 our bullishness is heavily tempered as the U.S. economic fundamentals are basically being kept on a leash as the Euro-crisis continuing to cast its spell over financial markets and the uncertainty over the extension of the payroll tax cut. Such trepidations in the economy will certainly add to the phobia in the public psyche, keeping the risks of further cutbacks in future defense budgets at a high.

Thus in the absence of clear triggers we retain a short-term Zacks #3 Rank (Hold) for the short term (1–3 months) for Lockheed Martin in-line with other defense primes.

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