Lockheed Martin's Growth Fueled by Net ROIC of 30%

The world’s largest defense contractor offers dividend growth above inflation expectations and a yield higher than the current 30-yr Treasury.    Lockheed Martin (LMT), with $45.4 billion in revenues, has a 5-yr average dividend growth of 21% and a current yield of 3.5%.

A good description of the company is from their website:

LMT is a global security and aerospace company principally engaged in the research, design, development, manufacture, integration, and sustainment of technology systems and products. The Company also provides a range of management, engineering, technical, scientific, logistic, and information services. It serves both domestic and international customers with products and services that have defense, civil, and commercial applications, with its principal customers being agencies of the United States Government. It operates in five business segments: aeronautics (31% of 2013 sales), missiles and fire control (17%), mission systems and training (16%), information systems and global services (18%), and space systems (18%).

 LMT manufactures the newest jet fighters, F-35, and its fortunes will pivot on this important defense business, both in the US and abroad. 

 Dividend increases have been fueled by an 8% earnings growth and a payout ratio that has expanded from 30% of earnings to 53%.  While unsustainable at this growth rate, a long-term dividend growth matching its earnings growth of 8% would remain a respectable combination. 

 LMT should not be considered a value selection as it is trading at a PE of 18 with an underlying growth rate of 8%.  Share prices are up 12% from early August, and up 50% over the past year, substantially outperforming the market.  However, LMT has been a solid dividend payer with a lower-than-market beta of 0.72.    

 Helping long-term eps growth has been a reduction in shares outstanding.  Over the past 10 years, LMT has reduced share count by 28% - from 443 million shares outstanding in 2004 to 319 million currently.  This has help drive both eps and share prices higher. The combination of dividend growth and share reductions is a double positive for long-term shareholders.  It should be anticipated LMT will continue this trend.

 Management has one of the highest and most consistent returns on invested capital (ROIC) at a whopping 34% to 43%, with a 6-yr average of 37%.  Based on a cost of capital of 7.3%, management generates an eye-popping 30% net ROIC annual return.       

Analysts at Stifel upgraded shares of LMT to Buy from Hold and raised the stock's price target to $220. Joseph DeNardi stated,

“We believe the cash flow generation outlook for Lockheed’s core business, combined with the expected cash recovery from its pension over the next several years, should support continued growth in the company’s dividend and share repurchase activity to a degree that will differentiate it from its peers.”

Other highlights include: Defense spending bottoming in fiscal year 2015.  Analysts anticipate growth in F-35 sales as production rates increase.  DeNardi believes Lockheed is the best way to play what it see as a challenging but stable outlook for defense budgets.

Equity income investors looking for strong dividend growth with current yields competitive with long treasuries should review LMT.  However, share prices are currently overvalued and capital gains may be hard to come by from here.  Waiting a bit for a pullback, and buying the dip, should be the most prudent approach to this dividend growth machine.

 First appeared in the Oct 2014 issue of Guiding Mast Investments newsletter.  Thanks for reading,   George Fisher