It’s been a rough start for the broad markets in 2022. Inflation concerns and the possibility of multiple interest rate hikes dominated headlines initially, and the escalation in geopolitical tensions has caused further headwinds.
However, as is in any market scenario, there are sectors that tend to outperform and underperform. With the Russian invasion into Ukraine, the defense sector is in focus. It’s therefore not surprising to see that Lockheed Martin (LMT) stock has surged by 18% over the last month.
It seems very likely that the uptrend will sustain for LMT stock. From a valuation perspective, the stock still trades at a forward price-to-earnings-ratio of 16.3. This is attractive considering the company’s fundamentals and the possibility of growth acceleration.
It’s also worth mentioning that in 2020, global military spending nearly touched $2 trillion. Even in the first year of the COVID-19 pandemic, global defense spending increased by 2.6% on a year-on-year basis.
This underscores the view that defense spending is somewhat immune to economic shocks. Moreover, with escalation in tensions, spending growth will accelerate. This positions Lockheed Martin for healthy growth moving forward.
Strong Order Backlog for Lockheed
One reason to like Lockheed Martin is its robust order backlog. As of December 2021, the company reported a backlog valued at about $135 billion. Furthermore, for 2021, the company’s total revenue was already $67 billion. The backlog therefore provides two years worth of revenue and cash flow visibility.
It’s worth noting that Lockheed has already provided guidance for operating cash flows. In 2022 and 2023, the company expects cash flow in the range of $8.4 billion. Further, the company expects a consolidated free cash flow (FCF) of $12.1 billion for the next two years.
This is important to mention because Lockheed currently has an annual dividend payout of $11.2 per share. Considering the FCF visibility, dividends are likely to sustain.
What’s more important is that the company’s order backlog is likely to accelerate in the coming quarters.
Recently, Germany announced that it will be nearly doubling its defense spending. The wealthy European country intends to buy U.S. made fighter planes for the first time in decades. Lockheed is likely to be a beneficiary.
It’s not just Germany, but most of the European countries have fallen short of the NATO defense spending target in the past. With the war in Ukraine persisting, it’s likely that other European countries will also accelerate defense spending in response.
Lockheed Martin also has orders from countries like Taiwan and Qatar. The key point is that the company is more diversified from a geographical perspective. In 2021, 28% of all sales were from international customers.
It’s therefore reasonable to expect that Lockheed will witness growth in its order backlog. This is likely to take LMT stock higher.
Wall Street’s Take
Turning to Wall Street, Lockheed has a Moderate Buy consensus rating, based on six Buy and seven Hold ratings assigned in the past three months. The average Lockheed Martin price target of $427.23 implies 6.75% downside potential.
Concluding Views
Last month, Lockheed axed plans to buy Aerojet (AJRD) in a $4.4 billion potential deal. Regulatory oversight concerns was the reason for dropping the deal.
However, it seems clear that Lockheed wants to take the inorganic route for growth and diversification. As of Q4 2021, Lockheed reported $3.6 billion in cash and equivalents. Furthermore, with robust free cash flow visibility, the company is positioned to pursue other opportunistic acquisitions.
Another point that deserves mention is that Lockheed is already diversified. In 2021, its aeronautics segment was the key cash flow driver.
However, revenue growth was higher in the Missiles and Fire control sector, and Rotary and Mission System revenue also accelerated. With the Missiles and Fire Control segment having higher operating margin, there is a case for EBITDA margin expansion in the next few years.
Overall, Lockheed seems well positioned to benefit from industry tailwinds. With a big addressable market, the company is likely to be a value creator.
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