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Long Boeing, short Lockheed

(Macro Ideas) / 21 May 2012

Lockheed martin, one of the world’s (and the Pentagon’s) largest defence contractors is in deep trouble.

One, Lockheed will be a victim of US budget cuts, as Washington winds down the wars in Iraq and Afghanistan, 85 per cent of Lockheed sales are dependent on the Pentagon. Two, the order backlog is falling, a negative indicator for future sales and margins. This is particularly true in Lockheed’s flagship Aeronautics division. Three, F-22 fighter jet production has peaked. Four, Australia and some EU/Gulf countries have decided to slow F-35 Stealth purchases. Five, missile margins are mediocre and falling. Six, NASA project cutbacks will hit space/shuttle projects. Seven, legendry Chairman/CEO Bob Stevens plans to retire and I expect lower margins in Electronic Systems. Eight, the F-35 programme development risk will not encourage the smart money. If Obama wins, there is headline risk on major programmes. Nine, defence contractors will underperform the index as European recession deepens.

Australia’s decision to cut defence spending by $5.5 billion as PM Julia Gillard downsizes the military will mean possibly no more sales of 12 Lockheed F-35 Joint Strike Fighters. Leon Panetta has already postponed the sale of 179 F-35 warplanes as part of the Pentagon’s planned $487 billion cutbacks in the next decade. It is also ominous that tow USAF National Guard pilots refused to fly the F-22 Raptors as it disoriented them. Pilot blackouts have already grounded F-22 Raptors in the past.

The Pentagon cutbacks are a sword of Damocles for Lockheed since defence/aviation is 85 per cent of sales. This will hit not just Lockheed’s F-16 and F-22 fighters but also the C-130 Hercules air lifter, missile systems, submarine warfare systems, radars, surveillance satellites and CIA/war on terror products. The cancellation of the Nasa constellation programme, which includes the next gen Space Shuttle, will also be a strategic blow to Lockheed. Can global sales make up for Pentagon cutbacks? No way. Lockheed only generates 13 per cent of its sales outside the US. The Raptor programme will probably be discontinued. The legendary firm that gave the world the Hubble telescope and the Stealth fighter now faces a major business model transition, particularly if Obama wins the election. I believe Lockheed Martin shares fall to 70 in the next six months.

I would take advantage of the stock market correction to buy Boeing, ideally in the 64-65 range. Why? Boeing’s Dreamliner R&D is complete, which means spectacular free cash flow yields. Boeing can easily deliver $80 billion in revenues and $5.70 in 2013 EPS as the global commercial aircraft momentum adds momentum. After all, Boeing’s order backlog is $380 billion, making it the world’s leading aerospace manufacturer. This means the world’s airlines and air forces have ordered more than 4000 commercial jets from Boeing. Unlike Lockheed, Boeing has major franchises in the Gulf, India, Central Asia, Europe, China, Southeast Asia and Latin America. Will Pentagon cutbacks hit Boeing? Of course. (guess who makes Apache attack helicopters?). Yet unlike Lockheed, its defence portfolio is far broader and global. My ideal pair trade is long Boeing, short Lockheed. So there!


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