Lockheed Martin Stock: Buy, Sell, or Hold?

Lockheed Martin (NYSE: LMT) stock is up 13.7% this year, and most of the gain comes after the company's recent second-quarter earnings report. Does the good news from the second quarter signal a buying opportunity, or is now the time to take advantage of the increase in the share price? Here's a look at what happened and how to think about the stock.

Lockheed Martin provides some positive answers

Two issues keep Lockheed Martin investors up at night:

• The delivery delays on the F-35, relating to issues with hardware and software updates known as the Technology Refresh 3 (TR-3)
• The difficulty in expanding profit margins -- an issue that many companies in the defense industry face right now

F-35 deliveries, some good news

After delivering only 98 F-35s in 2023 (compared to an expectation of 100 to 120), management started 2024 forecasting 75 to 110 F-35 deliveries . However, given that the TR-3 updates were supposed to be ready a year ago, investors had reason to feel cautious in 2024.

The good news from the earnings presentations was that Lockheed Martin resumed deliveries of the F-35 in the third quarter (the second quarter finished at the end of June), and management confirmed the target of 75 to 110 deliveries for 2024.

Speaking on the earnings call, CEO Jim Taiclet noted: "We continue to produce at a rate of 156 aircraft per year and expect to deliver 75 to 100 aircraft in the second half of 2024. Over 95% of TR3 capabilities are currently being flight-tested."

While you could drive a bus, or rather fly an F-35, through the width of the guidance range of F-35 deliveries, CFO Jay Malave said, "Over the next few months, we'll get much better insights into the induction and flow of aircraft going into the test and production cycle." As such, while the update is definitely a net positive, there's still some uncertainty over the TR-3 and the quantum of deliveries this year.

Image source: Getty Images.

Defense company margins

Due to ongoing conflicts and heightened geopolitical tensions, there's no shortage of interest in defense spending right now. Still, investors shouldn't automatically conclude that this means revenue growth is translating into margin expansion and burgeoning profits.

As you can see in the table below, the company's segment operating profit margin continues to decline, as does operating profit and free cash flow. Moreover, it's worth noting that Lockheed Martin is not alone in suffering margin pressure -- RTX and Boeing also face similar issues.

The reasons behind these issues come down to ongoing supply chain difficulties (many caused by the same conflicts that are guiding defense sales higher), raw material inflation, and difficulties executing fixed-price development contracts procured in less inflationary times. In addition, the U.S. government may well be utilizing the strength of its negotiating position with the defense industry -- as exemplified by former President Donald Trump's deal for a fixed-price contract on Air Force One -- to pressure defense company margins.

Data source: Lockheed Martin.

Margins are a significant concern among defense investors, but here, too, Lockheed Martin had some good news. Its second-quarter operating profit margin of 11.3% was ahead of the 11.1% reported in the same quarter last year. Malave also repeated the company's view that 2024 would prove a "low-water mark" for margins, with improvement expected in the coming years.

However, indicating ongoing challenges in the defense industry, Malave mentioned that profit margins would be squeezed in the second half due to expected losses from a classified missile program under development in the missiles and fire control segment.

A stock to buy?

Lockheed Martin now trades at slightly more than 20 times the midpoint of management's free-cash-flow (FCF) guidance. While the recent rise in the stock price is justified given some derisking on the F-35, a solid margin performance in the second quarter, and the guidance hike (previous guidance called for $7.175 billion to $7.375 billion in segment operating profit in 2024) the stock now looks fairly valued.

There's still some risk around the F-35 TR-3, and the margin pressures aren't going away anytime soon. In addition, while U.S. and global defense budgets are at all-time highs right now, they will have to keep breaking those records to keep defense spending growing. That's no foregone conclusion, given the state of sovereign debts.

As such, the 20 times FCF often applied to mature industrial companies looks fair here, and chasing Lockheed Martin stock higher might not appeal to most investors.

Lee Samaha has no position in any of the stocks mentioned. The Motley Fool recommends Lockheed Martin and RTX. The Motley Fool has a disclosure policy .