Lockheed Martin (NYSE:LMT) - A Potentially Undervalued Dividend Payer That is Outperforming the Downturn

Stjepan Kalinic
January 24, 2022
Source: Shutterstock

While the broad market is experiencing the worst start to a year since 2016, some stocks outperform by a solid margin.

Lockheed Martin Corporation (NYSE: LMT) has been such a company, quietly racking up modification contracts while still trading at an attractive valuation.

Check out our latest analysis for Lockheed Martin

Latest Developments

LMT beat the expectations for 2021 F-35 deliveries, delivering 142 jets to domestic and international customers, 3 more than expected. For 2022 the guided production goal is at 151-153 jets. While the company made deals with Switzerland and Finland in 2021, the focus is now on Canada, which needs to replace its fighter jet fleet, for a potential contract of US$14.8b.

Furthermore, the company signed a variety of new deals and modifications:

  • US$847m contract modification regarding materials, parts & components for F-35 Joint Strike Fighter aircraft
  • US$492m contract modification for logistic support to F-35 Joint Strike Fighter aircraft
  • US$324m contract modification to support the calendar year 2022 modification and retrofit activities for the F-35 Joint Strike Fighter program
  • US$286.4m modification contract for The Missle Defense Agency
  • US$102.4m contract for production and delivery of hardware components for Apache Attack Helicopter

This is an incomplete list of multi-billion contracts and modifications that the company received in several weeks.

Meanwhile, the U.S. Federal Trade Commission (FTC) delayed the vote on Aerojet Rocketdyne (NYSE: AJRD) acquisition, seeking more time to review the deal worth US$4.4b. LMT's CEO Jim Taiclet expects the deal to complete within this quarter.

Calculating the Intrinsic Value

We will use the Discounted Cash Flow (DCF) model on this occasion. Remember, though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

We use what is known as a 2-stage model, which means we have two different periods of growth rates for the company's cash flows. Where possible, we use analyst estimates, but when these aren't available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value.

We assume companies with shrinking free cash flow will slow their rate of shrinkage and that companies with growing free cash flow will see their growth rate slow over this period. We do this to reflect that growth tends to slow more in the early years than in later years.

Generally, we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF ($, Millions) US$6.52b US$6.75b US$6.86b US$6.56b US$6.40b US$6.34b US$6.33b US$6.36b US$6.42b US$6.50b
Growth Rate Estimate Source Analyst x8 Analyst x8 Analyst x7 Analyst x4 Est @ -2.34% Est @ -1.05% Est @ -0.15% Est @ 0.49% Est @ 0.93% Est @ 1.24%
Present Value ($, Millions) Discounted @ 6.2% US$6.1k US$6.0k US$5.7k US$5.1k US$4.7k US$4.4k US$4.1k US$3.9k US$3.7k US$3.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$47b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case, we have used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. In the same way, as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.2%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$6.5b× (1 + 2.0%) ÷ (6.2%– 2.0%) = US$155b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$155b÷ ( 1 + 6.2%)10= US$85b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$132b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$371, the company appears a touch undervalued at a 23% discount to where the stock price trades currently. Remember, though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

NYSE: LMT Discounted Cash Flow January 24th, 2022

The assumptions

We would point out that the most critical inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. The DCF also does not consider the possible cyclicality of an industry or a company's future capital requirements, so it does not give a complete picture of its potential performance.

Given that we are looking at Lockheed Martin as potential shareholders, the cost of equity is used as the discount rate rather than the cost of capital (or the weighted average cost of capital, WACC), which accounts for debt. We've used 6.2% in this calculation, which is based on a levered beta of 0.975. Beta is a measure of a stock's volatility compared to the market as a whole.

Looking Ahead:

In the last few weeks, Lockheed Martin has been doing much better than the rest of the market. While there are no guarantees this will continue in the future, we have to take note that, according to our valuation model, the company seems below the intrinsic value. Furthermore, it pays a solid, affordable dividend and has been steadily increasing over the past decade.

However, it's impossible to obtain a foolproof valuation with a DCF model. Instead, it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we determine why the company is trading at a discount to intrinsic value?

For Lockheed Martin, we've put together three relevant aspects you should assess:

  1. Risks: You should be aware of the 1 warning sign for Lockheed Martin we've uncovered before considering an investment in the company.
  2. Future Earnings: How does LMT's growth rate compare to its peers and the broader market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other High-Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock, just search here.

Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

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