Updated: Sep 22, 2019
As more government funds are directed towards defence initiatives the world over, aerospace corporations are leveraged to significant industry growth. Few names are better known than Lockheed Martin (NYSE: LMT) and Northrop Grumman (NYSE: NOC). With the growing influence of technology in this segment, these companies are increasingly looking like growth stocks.
Lockheed Martin: the US contractor of choice servicing Australia’s military
Today worth US$111bn, Lockheed Martin is the world’s largest defence contractor. With close ties to the US government, it is the leading US federal contractor. LMT also works with other countries like Australia, to which it recently sent new F35 fighter jets. With 100,000 employees globally and over US$50bn in revenue, it marks a significant rise for what was previously two separate entities.
This includes Lockheed Corporation, developer of the C-130 Hercules military aircraft, and Martin Marietta, known for its missile developments and the Mars Polar Lander. Their merger in 1995 paved the way for a new era of security and technology developments, with current business separated into four divisions - aeronautics; space systems; rotary and mission systems; plus missiles and fire control. In the last seven years LMT stock has jumped more than 300%.
Northrop Grumman: from times of war to the lunar mission and beyond
Until their merger in 1994, both Northrop Corporation and Grumman Corporation were prominent military and civilian aircraft manufacturers. The two companies were responsible for some of the most well-known aviation developments, including Northrop’s F-5 fighter jets, and Grumman’s role as principal contractor for the Apollo Lunar Module.
Nowadays, the merged entity operates across four key divisions: aerospace systems, innovation systems; technology services; and mission systems. With over 85,000 employees and US$30bn in annual revenue, Northrop Grumman has become a mainstay of the US economy. As a result, it’s no surprise it is now valued in excess of US$60bn, with the stock up five-fold since 2013.
Leveraged to a backdrop of investment and unrest
Both Lockheed Martin and Northrop Grumman are vital contractors to uphold the security of the US, not to mention foreign allies as well. They are positioned within their respective markets at the forefront of sophisticated technology development. As defence budgets grow – especially for the US government under President Trump – each company can expect to remain an integral beneficiary of investment.
With tension, hostility and unrest building, this serves as a tailwind for the defence industry. In particular, recent events in the Gulf region – including the drone strike in Saudi Arabia – as well as Chinese territorial disputes and North Korea, mean an ever-growing need for state-of-the-art innovative defence solutions. If any of these conflicts escalate it will translate into growing military requirements and sales growth.
Cutting edge product development
Given their heavily diversified competencies, both Lockheed Martin and Northrop Grumman have multiple revenue streams to drive sustainable growth. Pipeline products look set to act as a catalyst.
For Lockheed Martin’s aeronautics division, the company has secured a US$32m deal to modify and retrofit F-35 supersonic fighter jets. The full F-35 program is LMT’s largest, with the US government targeting inventory of 2,456 aircraft in the years ahead. This is in addition to demand from 11 other foreign governments, including Australia. At June 30 LMT had 341 production aircraft in backlog. Once production ramps up, this is set to contribute strongly to the bottom line.
Beyond that, Lockheed’s rotary missions division has secured a US$50.3m modification contract to integrate and test the Aegis Weapon System across the naval fleet until 2024. As the world’s premier naval air defence system, it has also received notable interest from the likes of Japan, South Korea and Australia, so there is opportunity for further upside.
Northrop Grumman are pinning their hopes on the next iteration of B-21 stealth bombers, with the Air Force expected to buy up to 100 aircraft for US$80bn. The defence contractor is also poised to land an initial US$11bn contract to replace Boeing’s current intercontinental ballistic missiles (ICBM).
Robust earnings growth and free cash flow
In their recent quarterly results, each business lifted sales and earnings strongly, while also upgrading their respective outlooks. Furthermore, free cash flow remains sizeable, which is allowing both companies to pay out modest dividends and repurchase stock.
Lockheed Martin reported 23.5% EPS growth versus Q2 2018, while net sales climbed 7.7% to US$14.3bn. All segments in the business delivered year-on-year sales growth, albeit the largest came from missiles and fire control. There, revenue climbed 16% to US$2.41bn, and operating profit leapt 17% to US$327m. With a total backlog of US$136.7bn – the majority of which comes from its three other segments – LMT can expect to drive higher sales and margin growth across its product mix.
For Northrop Grumman, EPS is expected to rise from 9% in FY19 to 15% in FY20. It is now eight consecutive years the company has achieved annual EPS growth. Acceleration should come on the back of revenue and cost synergies from integrating its US$7.8bn acquisition of Orbital ATK, as well as demand for the E-2D aircraft – including a US$3bn US Navy order.
Mission systems were the strongest growth contributor in Q2 as sales rose 9% to US$3.13bn and operating income jumped 15.9% to US$408m. International sales for the innovation systems division set a new record and supported operating margin growth of 150bp.Northrop’s US$63bn backlog and US$28.5bn of net awards year-to-date across all segments provides a platform for future growth, as does Orbital’s extended geographic and capabilities coverage.
Paving the way for defensive innovation
The aerospace and defence subsector has long been a conservative area, however with the advent of technology, and the emerging nature of sophisticated global security threats, it represents a growth industry. Lockheed Martin and Northrop Grumman are leaders in this field, relied upon by governments across the world. Testament to this is their role in cutting edge product development like F-35 fighter jets, the Aegis Weapon System, B-21 stealth bombers, and next-gen ICBMs.
With multiple divisions providing a sound base for innovation, both companies have managed to consistently grow earnings. They remain positioned to do so as key products and services become essential needs for international governments.