Two weeks ago, Cramer made a point of telling a caller on his show that he believed Lockheed Martin (LMT) was the best bargain in defense (Lockheed Martin: Cramer’s Best Defense Stock). Specifically, here is what he said:
“Lockheed Martin is a buy. Now, a lot of people were disappointed by the last quarter, I say get a life. This is a company generating a gigantic amount of cash. It’s not expensive. It’s very well run. And as far as I’m concerned, this is the best bargain in the defense group. LMT, Lockheed Martin, pull the trigger right now.” — CNBC’s Mad Money 10/12/2009
Since that time, Lockheed reported quarterly earnings that were 13% better than consensus estimates and they raised the quarterly dividend by 10.5% to $.63 cents per share starting in December. However, the company forecasted fiscal 2010 earnings per share slightly below where analysts’ estimates had pegged them and the stock sold off in reaction. At Ockham, we have a longer term investment focus and believe that the market overreacted to the conservative forecasts. From our standpoint Lockheed actually performed reasonably well in the previous quarter and raising the dividend is a signal of confidence from management. The implied dividend yield of the next four quarters comes out to about 3.5%.
We are not blind to the challenges LMT faces with pension liabilities and the possibility of reduced defense spending ahead, but by our methodology the stock is too cheap trading at less than ten times the lowered 2010 earnings guidance (as well as 2010 analysts’ estimates). The fundamentals strengths of cash earnings and revenue growth have continued to improve recently as well.
Apparently in light of recent developments, Cramer has shifted his perspective on Lockheed as of Monday night’s show. Although Lockheed beat estimates, Cramer referred to it as a bad quarter and said that Lockheed is suffering from a priority shift at the Pentagon. According to Cramer, Lockheed is saddled with programs that the Pentagon no longer wants, while Northrop Grumman (NOC) has the sort of capabilities that fit the goals that the military is looking to achieve in Iraq and Afghanistan.
“The day after Lockheed disappointed Northrop Grumman came out with a solid beat and a really nice outlook. The difference is stark. Lockheed seems to be losing programs left and right. Northrop Grumman won $10 billion of contracts in the third quarter…
This is all about what the pentagon wants and Northrop Grumman has it and Northrop is getting tons of new contracts. A $2.4 billion contract to overhaul the USS Teddy Roosevelt. $3 billion for maintenance of the common ground system. $150 million for lighting targeting and sensor systems. All of Northrop Grumman systems did well. Aerospace systems up 5%. Electronic systems up 2%. Information systems and technical up 4% and ship building up 14%. In the past Northrop Grumman has been among the worst of the defense contractors, a company plagued by pension problems and crummy execution. Amazingly now it’s Lockheed Martin with the pension problem and Northrop Grumman indicated it made a last sizable pension contribution for a while…
Cheaper, faster growth, same yield. I think Northrop Grumman is the better stock and the better company.” — CNBC’s Mad Money 10/26/2009
This is a clear reversal from his opinion of just two weeks prior, and it is his prerogative to change his opinion as more evidence is made available. While he may be right about the shifting priorities from the Pentagon, we are sure that Lockheed will not be caught unaware with no alternative course of action. They will continue to compete for contracts same as they always have, and for now we are not overcome with concern for future sales. From our perspective, he seems to have written off LMT for dead rather quickly (especially considering his bullishness two weeks ago).
As for Northrop Grumman, we have a Fairly Valued rating at the current price levels. They certainly had a nice quarter in terms of gaining business, which we cannot overlook. We will consider an upgrade on these shares when the new revenue begins to improve their ability to generate cash earnings. As for right now, Ockham’s take is that the value play remains Lockheed, and they have only become more Undervalued in the past two weeks.
