Although its stock price is at 52 week highs, analysts expect LMT's Q2 earnings call on 18 July to reflect a ~7% reduction in earnings and 3.5% reduction in revenue. While we note that LMT has been a consistent surpriser to the upside in its quarterly earnings calls, we stick with our longer term focus with this update on the company's #1 program and driver of its fortunes: the F35.
Fully 23% of LMT's $47B in net sales in 2016 came from the F35
- Current Deliveries. Halfway through the year, the company appears to be behind on achieving its forecast of 66 for the year but ahead of the Defense Contracting Audit Agency's forecast of only 57. First half performance has been impacted by overhang from the correction of a 2016 insulation technical issue and growing pains among suppliers.
- Orders. The pace and scope of getting on contract is improving as signified by the recent $5.5B Unilateral Contract Action for 74 Lot 11 (FY17) aircraft. The timing is significant in that previous contracts, e.g, Lot 9 (FY15) and Lot 10 (FY16), have taken up to two years to negotiate which has resulted in the requirement for massive ($1B) company cash outlays to keep suppliers on track. Faster contract processing and more forward funding will help company cash flow.
- Congress. While there will always be challenges to costs and nearly everything else about the largest DoD program ever, momentum on the Hill for the F-35 has clearly shifted in its favor:
- The full House has authorized 84 F-35s for FY18 compared to the President's request for 70 aircraft and the 74 approved in FY17. The SASC has recommended procurement of 94. The difference will be resolved in conference and will not be less than 84.
- For the first time, Congress has added EOQ money funds that will enable a block buy. A block buy contract announcement for ~440 US and international aircraft for the years 2018-2020 should come soon.
- House NDAA language orders DoD to buy tooling, etc in order to sustain a full rate production rate of 146 US F-35s aircraft per year by 2021. Previous estimates have been for a US rate of 120 aircraft per year. International sales (estimated 50 acft in 2017) are additive to the US procurement.
- Headline noise. Keep news in perspective.
- Cost increase? DoD recently released its annual acquisition report for 2016 and it shows a $27B increase in the total production cost of the F35 program ($406B vice $379B). This is a result of a change in long-term Air Force plans to end production in 2044 vice 2038. A lot can happen in 21 years. This has no impact on the critical near term unit cost of the F35A which continues to come down: $94M in FY16, heading towards no more than $85M by FY19. LMT has promised even lower.
- Total buy reduction?
- Given Congressional desire for a light attack aircraft in the USAF inventory, Air Force desire to buy a new Penetrating Counter Air capability, and the major strategic reviews underway in the Pentagon, there are bound to be reports of a reduction to the planned total US buy of 2,443 F-35s.
- Investors should be cautious in assessing the impact of these stories. The critical factor for near and mid-term LMT revenues is the rate of buy over the next five years not the total over the next 27 years.
