The slowdown in activity of defense companies such as Lockheed Martin Corporation (NYSE:LMT) and The Boeing Company (NYSE:BA) didn’t seem to curb the growing demand for these companies’ stocks. During the year (up to date) shares of Lockheed Martin rose by more than 17% and Boeing’s stock by nearly 36%. Will these companies’ stocks continue to rally? Are these companies overvalued?
Decline in revenues
Following the implementation of sequester on the U.S budget may have had some adverse effect on these companies’ growth in revenues in the first quarter of 2013: Lockheed Martin Corporation (NYSE:LMT)’s revenues declined by nearly 2%; The Boeing Company (NYSE:BA)’s net revenues fell by 2.5%; revenues of Northrop Grumman Corporation (NYSE:NOC) slipped 1.5%. Since the sequester included only $85 billion budget cuts in 2013, the effect was likely very minimal.
In particular, Lockheed Martin’s largest business segment (28% of revenues) – Aeronautics had a 14% drop in revenues during the first quarter of 2013 (year-over- year). According to the company, the drop in sales was due to lower net sales of F-16 aircrafts. This business segment’s profit margin is 11.8%. In comparison, the company’s missiles and fire control business segment, which accounts for 18% of the company’s total revenues, rose by 12.5%. Moreover, this segment is the most profitable at 17.3%. If the company will keep seeing a rise in revenues in this segment, it will also raise Lockheed Martin Corporation (NYSE:LMT)’s profit margin.
Boeing also had a drop in military aircraft sales of 3% during the first quarter of 2013. But the company also had a 2% decline in revenues in commercial aircrafts. Furthermore, following the recent decrease in revenues, the company estimates its revenues will grow by only 0.3% to 4% in 2013 (year-over-year), which is roughly the growth in U.S inflation. This isn’t an impressive growth rate.
Northrop Grumman is even less optimistic and according to the company’s outlook for 2013 its revenues will drop by almost 5%, and its operating profit margin will fall to 10-11%. This glum outlook is likely to pull down the company’s stock in the coming months.
Finally, looking forward, these companies revenues may continue to dwindle especially if U.S policymakers will scale down on defense in 2014 and cut the budget in order to lower the growing budget deficit.
Valuation
In order to understand whether these companies’ stocks are overpriced, we will have to examine these companies’ value. For that end, let’s examine these companies’ enterprise value and their EV to EBIT ratio in order to compare the companies mentioned above.
The table below shows the summery of data of all three companies and the average Aerospace/Defense industry.
This type of calculation accounts for these companies’ different financial structure including their debt and cash. The yearly EBIT is based on the past four quarters (ending in the first quarter of 2013). As seen, Lockheed Martin Corporation (NYSE:LMT)’s EV to EBIT ratio is the highest at 8.48, which is very close to the industry average. On the other hand, The Boeing Company (NYSE:BA) and Northrop Grumman Corporation (NYSE:NOC) have a much lower EV to EBIT ratios, which are much lower than the industry average. This measurement shows a different picture than the regular P/E. The P/E of Lockheed Martin is only 12.5, which is much lower than Boeing’s 19.21 P/E. These findings suggest at face value that these companies are still relatively cheap particularly The Boeing Company (NYSE:BA) and Northrop Grumman Corporation (NYSE:NOC) so that it’s worth considering owning these companies’ stocks.
Profitability and dividend
Despite the drop in revenues, these companies continue to show high profit margins: Northrop Grumman is leading the way with nearly 12.4% profit margin. In comparison, Lockheed Martin Corporation (NYSE:LMT)’s profitability is 10.1% – an increase from the parallel quarter in 2012 at 9.2%; Boeing’s profit margin is 8.1% – very close to last year’s profit margin. The high and stable profit margins translate into high dividend yields in which Lockheed Martin Corporation (NYSE:LMT) leads the way with an annual yield of 4.24%. The Boeing Company (NYSE:BA)’s annual dividend yield is the lowest at 1.9%. Northrop Grumman Corporation (NYSE:NOC) is in the middle of the pack at 2.95%.
This means, even if these companies’ revenues won’t grow they will maintain their high profitability and keep offering relatively high dividend yield.
Take away
Leading defense companies are likely to be adversely affected by the future U.S government budgets cuts. Moreover, they may also show poor growth in revenues. Despite the expected drop in revenues, these companies still have high profit margins, high dividend yields and their valuation isn’t high for the industry. These factors still make these companies good investments to consider.
Lior Cohen has no position in any stocks mentioned. The Motley Fool owns shares of Lockheed Martin Corporation (NYSE:LMT) and Northrop Grumman Corporation (NYSE:NOC).
The article Is It Time to get Into Defense Stocks? originally appeared on Fool.com.
Lior is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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