Will Lockheed Martin Stock Face Headwinds From An Underperforming Sikorsky?

  • Lockheed Martin has warned investors that its newly acquired Sikorsky helicopter unit could underperform in 2016.
  • The company says that low oil prices are to blame for this scenario.
  • How will this development impact Lockheed Martin stock?

Leading defense equipment manufacturer Lockheed Martin (NYSE:LMT) has fired a warning to investors regarding its new Sikorsky helicopter unit saying it could badly underperform expectations and pull down the company’s performance in the process. Lockheed says Sikorsky, which the company bought for $9B from United Technologies (NYSE:UTX) could see significantly lower sales in FY16 due to oil prices which have continued to fall (Oil companies use commercial helicopters like Sikorsky to shuttle their employees to offshore platforms). Indeed, Lockheed Martin CFO Bruce Tanner told analysts last month that the company had already cut its projections for commercial helicopter sales by half since July 2015 when the Sikorsky deal was first announced. Lockheed now seems to be unusually pessimistic about Sikorsky's prospects, and says it’s not sure if it will see any cost synergies that it had anticipated from integrating Sikorsky with its core defense aircraft business:

"We believe that we will benefit from the integration of our products and technologies with those of the Sikorsky business and realize synergies and potential for long-term growth, as well as expanded capabilities and customer relationships as a result of the acquisition," Lockheed Martin said in a 10-K filing.

"However, the integration process is complex, costly and time-consuming and we may not be able to capture anticipated synergies, tax benefits, cost savings, and business opportunities in the time frame anticipated, or at all.’’

Now, this looks like boilerplate risk factors language and corporate double-speak from Lockheed Martin. After all oil prices were already in free fall by the time the deal was announced in July so Lockheed must have at least anticipated this risk to some degree. Moreover, Lockheed had already issued rather weak 2016 guidance with weaker-than-expected EPS. Lockheed Martin said that it expects 2016 revenue of $49.5B-$51.5B whose midpoint was above consensus of $49.52B by Wall Street. The company also said that it expects EPS of $11.45-$11.75, way lower than the consensus of $12.23.

Unless there is something else that the company is not telling investors, it appears as if Lockheed is basing its Sikorsky projection solely on low oil prices. The good news is that this is likely to be a temporary headwind. Several analysts have already begun tentatively calling the bottom of the oil market with Brent crude hovering around $35/barrel all week. Although bears see the current rally as having happened too early and say prices could retrace their way to $30/barrel or lower, this is definitely the first sustained rally the market has seen in months which is a positive sign.

Meanwhile, there are no reports yet of any order cancelations for Sikorsky, and few if any are likely to be forthcoming; at least not on the basis of low oil prices. Lockheed Martin recorded a healthy growth in order backlog during the last quarter after new orders jumped from $80B to $100B partly helped by healthy growth in Sikorsky orders. And, these orders had been placed in an environment of low oil prices. If oil prices continue to remain depressed, there is a possibility that several customers might withhold their orders. But ultimately older fleets will need replacing regardless of whether oil prices stay depressed or not so this is likely to be a temporary problem rather than a long-term issue.

Little Downside to Lockheed Martin Stock

Sikorsky's had revenues of $7.5B in 2014, or ~15% of Lockheed Martin’s revenue so a dramatic slowdown in the segment’s performance certainly can badly impact the company’s performance. But this scenario is not likely to affect the long-term performance of Lockheed Martin stock.

Although Lockheed Martin's F-35 program is still beset by many problems, the situation is likely to gradually improve for Lockheed. The company delivered 53 F-35 jets in 2015, good for 20% of Lockheed Martin's revenue, with a production ramp expected as the quarters roll on. With more than a trillion dollars in sunk costs, F-35 program life expectancy is expected to exceed 50 years. But that, of course, depends on the ability of F-35 to maintain technological superiority over enemy aircraft.

Lockheed stock is unlikely to be affected much by speed bumps such as Sikorsky's due to the fact that defense budgets tend to be quite immune to poor economic cycles. The defense budget for 2016 has already been finalized at $605B compared to $596B in 2014. With the infamous defense budget cuts now in the back mirror, Lockheed stock has little downside and could soar if F-35 production ramp and orders exceed expectations.

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