Fitch Affirms Lockheed Martin at 'BBB+'; Outlook Stable
KEY RATING DRIVERS
The Stable Outlook reflects LMT's competitive position in the global defense and security industry; the company's strategic importance to the U. S. government; healthy operating margins; significant cash generation; and financial flexibility. LMT's debt and leverage have more than doubled compared with 2014 levels as a result of acquisitions and cash deployment to shareholders, both of which contributed to a one-notch downgrade in late 2015. Aside from higher leverage, Fitch believes LMT's credit profile is consistent with an 'A' category rating, and the rating could trend higher if the company materially reduces debt, although Fitch believes this is unlikely over the next two years.
LMT's ratings are also supported by the company's liquidity position; increasing international sales; successful cost reduction efforts; large backlog ($91.4 billion at the end of September 2016); and the stabilization and growth of the F-35 program. The Outlook is also supported by the current U. S. and international defense spending plans.
Rating concerns include cash deployment; the integration of the Sikorsky acquisition; the large pension deficit ($11.6 billion at the end of 2015); some modest program concentration; and rising competitive pressures in parts of the space sector.
More Aggressive Cash Deployment
LMT's cash deployment has become more aggressive and shareholder-focused in the past 24 months, which contributed to the downgrade in November 2015. LMT announced a shift in strategy in late 2014 with an objective of returning the vast majority of FCF to shareholders in 2015-2017. LMT confirmed this new strategy when it announced the Sikorsky acquisition. Fitch previously expected LMT would reduce share repurchases if it executed a major acquisition. Fitch expects annual FCF in 2016 to 2018 will be approximately $2 billion, compared to $2.2 billion in 2015.
Government IT Spin-Off
LMT completed the spin-off of its Information Systems & Global Solutions (IS&GS) business in August 2016, merging with Leidos Holdings, Inc. As part of the deal, LMT received a $1.8 billion cash payment, which Fitch expects will be used for share buy-backs and debt reduction. The transaction leaves LMT more focused on its core businesses, but it also reduces diversification.
U. S. Defense Spending Outlook Improving
U. S. defense investment spending increased in 2016 after a three-year trough and Fitch expects continued solid spending levels in 2017 and beyond, assuming budget caps are overridden. Risks remain from budget caps, continuing resolutions, and political disruptions. Fitch considers LMT's defense portfolio to be a strength because of its positions on programs such as the F-35, which accounts for approximately 20% of sales. Fitch's credit view of the U. S. defense sector was reinforced by the elections, which Fitch viewed as credit positive for the sector.
International Defense Spending Outlook Favorable
LMT generates approximately 25% of its revenues from customers outside the U. S., and it hopes to push this up to 30% over the next several years. Fitch and BMI Research forecast non-US defense markets will lead global defense spending trends over the next several years. Fitch and BMI expect the relevant parts of the addressable global defense market to rise between 3% and 5% over the next three years, and estimate this market in 2016 to be approximately $400 billion-$425 billion. The U. S. budget accounts for 45%-50% of the addressable market by Fitch's estimates, but its growth is less than in non-U. S. markets.
LMT is the lead contractor on the F