Financial Performance of the Company through Ratio Analysis - Lockheed Martin - Case Study Example

Lockheed Martin Financial Analysis

1.0 Introduction

Many people argue that the primary purpose of limited companies is to maximise the wealth of shareholders. However, in reality, companies pursue both financial and non-financial goals. Although most of the decisions seem to maximise shareholders value, some objectives of listed companies are non-financial. Over the recent past, economists have criticised the wealth maximisation objective because it lowers other stakeholder’s welfare. Today, firms use different strategies to achieve their goals and objectives. They try their best to achieve both internal and external objectives. For instance, many companies strive to maximise the wealth of shareholders, increase revenue, expand, and achieve long-term sustainability during financial crisis. However, these goals can only be achieve through strategic management. The strategic objectives of a firm establish what they are trying to achieve (Choi & Wang 2015). This paper critically analyses Lockheed Martin by evaluating its financial objectives and performance. These goals are achieved through a critical analysis of financial statements and ratio analysis. Specifically, ratio analyses are employed to establish the financial performance of the company.

The strategic plan of Lockheed Martin is the building block of its strategic plan, which helps the company to compete in the market. The financial objective of Lockheed Martin is to increase revenues by more than 10 percent annually. The company also priorities increasing operational efficiency in order to support a net profit increase by 10 percent annually. Lockheed Martin also has constituent strategic objectives, which include offering outstanding customer service to increase customer retention. These entire objectives have been supported by the management’s commitment to excellent performance to realise the overall goals of the company. Moreover, this report also offers insight to potential investors on the financial performance of the company to help them make sound investment decisions. Specifically, it argues that Lockheed Martin has an impressive performance and,thus, investors should invest in the company.

2.0 Snapshot of Lockheed Martin

Lockheed Martin is a global aerospace and defence company which is recognised worldwide. The company was formed as a result of a merger between Lockheed Corporation and Martin Marietta. It is headquartered in Maryland, Washington DC. It employs more than 26,000 workers worldwide and the current CEO is Marillyn Hewson. Lockheed Martin is one of the largest defence contractors in the world based on 2014 revenues. More than 80 percent of Lockheed Martin's sales come from military sales which receive nearly 10 percent of its budget from the Pentagon. Lockheed Martin operates in five business segments that include information systems, aeronautics, space systems, missiles and fire control and mission systems. Recently, the company received collier Trophy for developing F-22 Raptor fighter jet (Lockheed Martin Annual Report 2015).

In 2013, Lockheed Martin earned $14.1 billion in revenues from aeronautic segment which represented a 31% mark up of total revenues. This segment has been strongly supported by the production of advance fighter jets such as F-22 and F-35 joint strike fighter jet. About 50 percent of aeronautic revenues come from these two programs alone. Due to the high level of fighter aircraft from the US government, this segment is expected to remain profitable in the near future which will boost overall profitability of the company. For instance, the US government’s current demand for fighter jets is 2,443 in the next 10 years which will help the company to remain profitable (Lockheed Martin Annual Report, 2015). The information systems and global solution accounted for $8.4 billion in 2013 which represented 18 percent of total sales (Lockheed Martin Annual Report, 2015). It includes services offered by the company, such as integrated information technology systems, cyber security, and data analysis. The missiles and fire control segment represented 17 percent of total sales at $7.8billion (Lockheed Martin Annual Report, 2015). This segment include missiles and air defence systems, air to air strike weapons, and fire control systems. The mission systems and trainings accounted for $7.1 billion which is about 16 percent of total revenues (Lockheed Martin Annual Report, 2015). This segment is made of ships and submarines, radar systems, and littoral combat ships. Finally, the space systems represented 18 percent of total revenues in 2013 which is about 18 percent (Lockheed Martin Annual Report, 2015). This segment includes engineering and production of satellite, space transport systems, and defensive missiles.

3.0 Financial objective of Lockheed Martin

Lockheed Martin has both financial and non-financial objectives which establish its strategic plan (Lockheed Martin, 2014). These financial objectives of the company can be obtained from 2015 annual report. Precisely, the financial objective of the company is to maximise shareholders’ value.

Table 1:

The shareholders wealth maximisation goal can be observed in table 1. A company maximises its shareholders value by paying constant dividends. Shareholders expect Lockheed Martin to increase their value by managing the relationship between all stakeholders to ensure all objectives have been achieved. Shareholders expect that equity raised by Lockheed Martin should be used to generate revenues. These revenues are then declared to the shareholders as dividends. From table 1, Lockheed Martin has been paying constant dividends, which have improved from 4.78 in 2013 to 6.15 in 2015 (cash dividend per common share). According to Jones and Felps (2013), a firm can create shareholders value by investing in new products or acquiring new businesses. This argument converges with Queen (2015) who notes that Lockheed Martin maximises its shareholders value by forming mergers and acquisition. For instance, from the cash flow statement, Lockheed Martin has increased its capital expenditure to improve efficiency and profitability; this goal is inconsistency with the long-term sustainability objective of the company.

Table 2:

Moreover, in 2015, Lockheed Martin acquired new businesses. The acquisition figure $9003 on the cash flow statement (Table 2) represent the acquisition of Sikorsky Aircraft which is one of the leading military helicopter manufacturers for $9.0 billion. However, this figure is reduced to $7.1 due to tax benefits resulting from the transaction (Christopher, 2015). The CEO argued that he was confident that the acquisition of Sikorsky would increase the long-term sustainability goals of the firm. Concisely, it would increase its chances of survival during the current financial crisis.

The recent financial crisis has affected many companies in the defence industry. Lockheed Martin is not an exception. In 2014, Lockheed Martin reported a 1% decline in revenue in its first two quarters. However, overall, earnings grew by 3% which was strongly supported by a 5 % increase in sales in the Aeronautics division (Lockheed Martin Annual Report, 2015). The decline in sales during 2014 financial year was associated with the current financial crisis and reduction in demand for Space Systems and Information System segments. Although the company had recorded a decline in revenue in 2014, its earnings per share improved from $10.5 to $11.15 (Lockheed Martin Annual Report, 2015). This is an indicator that management is maximising the wealth of shareholders by paying constant growing dividends. Consequently, share price have also been on the rise. This notion has been clearly reflected on share price as shown on Table 3.

Table 3:

Year

2014

2015

2016 (today)

Dividends

10.5

11.15

-

Share prices

191.56

217.15

239.45

4.0 Financial performance of the company through ratio analysis

Antonowicz (2014) denotes ratio analysis as a financial tool used by investors to evaluate financial statements of a company. Specifically, ratio analysis is used to analyse the financial performance of a firm to help both management and investors to make sound investment decisions. There are different type of ratios that can be employed to evaluate the financial leverage, profitability, and market value of Lockheed Martin. They include profitability ratios, gearing ratios, financial market ratios, and efficiency ratios. Profitability ratios assesses the ability of a firm to employ its resources to generate revenues while gearing ratios measure the extent to which a firm has been financed by external sources of capital. Efficiency ratios, on the other hand, measure the ability of a company to utilise all its assets effectively to generate profits (Antonowicz, 2014). All these ratios shall be determined to define the long-term profitability of Lockheed Martin.

4.0.1 Profitability ratios

Profitability ratios measure the ability of a company to generate revenues relative to sales, asset and equity (Antonowicz, 2014).In other words, profitability ratios are financial metrics that measures the ability of a company to generate profits from invested capital. These ratios include return on asset, return on equity, return on invested capital, and asset turnover ratio. As a rule, the higher the ratio, the better the performance of the company.

Table 4:

From the ratios above (Table 4), it can be observed that Lockheed Martin is not utilising all its assets effectively to generate profits. For instance, the return on invested capital has been declining from 43.03 in 2012 to 27.16 in 2015. This is an indication that the company profitability has been declining in the last three years. The declining sales are associated with the sequestration of the government which has decreased its defence spending by $50billion until 2023 (Antonowicz, 2014). Although the company has been trying to diversify its market into other areas, it has not been able to offset revenues lost from government contract. Moreover, the company has faced major setback on its F-35 project which was expected to support increased revenues (Lockheed Martin Annual Report, 2015). As a result, Lockheed Martin’s revenues have been declining.

The return on asset ratio measures the ability of the firm to generate revenues from its assets. Lockheed Martin’s return on asset ratio has remained stable in the last five years. This is an indicator that the company is utilising its assets effectively to generate revenues. The return on asset recovered in 2015 after continuous decline during 2012 and 2013. However, the net margin ratio has increased slightly from 5.82 in 2012 to 7.81 in 2015. This is an indication that, although the company is facing low demand for its defence products and services, it has been able to maintain high profits margin. The high profit margin has been contributed by the ability of the company to reduce operating expenses. For example, the company has reduced costs significantly through layoffs and factory closure. Lockheed Martin has reduced the number of workers from 146,000 in 2008 to 116,000 in 2014 (Lockheed Martin Annual Report, 2015). The company has reduced its overhead costs, thus, increasing its profitability margins.

4.0.2 Gearing ratios

The financial gearing ratios are also referred to as leverage ratios. They show the extent to which a company is financed by borrowed capital or fixed return capital (Antonowicz, 2014). These ratios can also be used to indicate the extent to which a firm is financed by owner’s equity vs. fix return capital. The gearing ratios are used to assess the capital structure of the company and its financial position in the long-run. It is critical to assess the gearing ratios of Lockheed Martin for two reasons. One, they can help to assess the financial risk of the company; financial risk refers to the risk that Lockheed Martin will go into liquidation due to nonpayment of both interest and principal the payment which is a legal obligation of the company. Second, they can help assess the impact of fixed return capital on ordinary shareholders.

Table 5:

From table 5, the debt to equity ratio is higher than the industrial average. This is an indication that the company is very highly geared. Lockheed Martin is highly financed by fixed return capital which exposes the company to high financial risks. The high gearing ratio is also evident from the balance sheet figures. The total asset from the statement of financial position is $49,128 compared to total debt of $46.031.Therefore, investors must ensure that they evaluate other aspect of the organisation before investing their money. In summary, Lockheed Martin is highly geared which means it has a high financial risk.

4.0.3 Liquidity ratios

According to Chue (2015), liquidity ratios measure the ability of a company to meet its short-term maturing obligation as and when they fall due. These ratios include the current and quick ratio which measures the ability of Lockheed Martin to meet its short-term maturing obligation when they fall due. The liquidity ratios are shown on table 6.

Table 6:

From table 6, the current ratios have remained stable in the last three years. This is an indication that the company will be able to meet its short-term maturity obligations when they fall due. In 2014, there was significant drop current ratio which was caused by a shortage in cash flow. The declining sales level during the year caused cash flow to decline, thus, affecting the current ratios (Zha & Liang, 2015). However, the quick ratios have been declining in the last five years. Quick ratios measures the ability of a firm to meet it short-term obligations from the most liquid assets (Chue, 2015). This decline suggests that the company may not be able to meet its current obligations when they fall due.

4.0.4 Efficiency ratios

The efficiency ratios measure the ability of a company to utilise its assets and liabilities to generate revenues (Hai et al., 2015). The efficiency of Lockheed Martin can be calculated by establishing the turnover of receivables, usage of equity, repayment of liabilities, and inventory turnover. Some of the ratios used to estimate efficiency include asset turnover, receivable turnover, and payable period.

Table 7:

From the efficiency ratios above, day’s inventory period has continuously been increasing in the last five years. This is an indicator that the company is not turning stocks into sales rapidly. Ideally, the current global financial crisis, coupled with U.S military cut-down spending, has affected the efficiency of turning stocks into sales. The same trend is recorded on the receivable turnover ratios, especially between 2014 and 2015. This shows that the company is not collecting its debts appropriately.In summary, the efficiency ratios of Lockheed Martin has been declining in the last few years which is an indicator that the company is not utilising all its assets and liabilities efficiently to generate revenues.

4.0.5 Valuation ratios

Valuation ratios are some of the most critical ratios when valuing a firm. They show the value that can be attributed to a share or the value of shareholders (Andrijasevic & Pasic, 2014). These ratios include the price to earnings ratio, price to sales ratio, price to cash flow ratio, and price earning variations.

Table 8:

The price to earnings ratio measures the price of a share at a particular time to its net earnings in the last 12 months. It can be calculated using the following formula.

(P/E) = stock price / net earnings per share (Kirkham 2012)

Lockheed Martin has a higher price to earnings ratio compared to the industrial average. It is an indication that the earning per share from retained earnings is better than the industrial average.

The price to book value ratio has outperformed the industrial average, a good indication that the company’s book value is better compared to other firms in the same industry.

6.0 Lockheed Martin long-term profitability

Lockheed Martin’s profitability has been stable in the last five years. However, profitability declined by 1% in 2014 which was attributed to the current financial crisis. The decline in revenues was caused by a major decline in Space Systems and information Systems segment. However, in general, Lockheed Martin has remained profitable because the sales outlook has remained unchanged. In 2014, the company changed its earnings per share and operating profit. Operating profit changed from $5,475M to $5,625M (Ally, 2014). The company has continued to show exceptional performance in the last few years. Moreover, the EBITDA has remained stable between 10%-13%. However, due to the current budget-cut, the company might report a slowdown in earnings. As posited by Ally (2014), the U.S government, through its budget control Act, has reduced its spending on defence equipment’s which is likely to affects sales in the next few years. The impact of budget-cut is referred to as sequestration where the department of defence estimated that the government has imposed a $50billion cut through to 2023. In fact, the sequestration, as asserted by Ally (2014), is expected to affect other defence companies such as General Dynamics and Boeing. The budget-cut on the defence industry is responsible for the fall in revenue by $1.3 billion in 2013.

However, Lockheed Martin has been trying to reduce the impact of sequestration by diversifying in other fields. Ally (2014) also argues that the impact of sequestration would be muted on the Aeronautics segment because it has a longer production cycle. The other segments have a shorter production cycles, thus, the impact will be severe in the near term. The Aeronautic segment has a longer production cycle and, therefore, it has received money in previous years. Lockheed Martin has decided to overcome sequestration, coupled with the global financial crisis, through cost reduction measures. For instance, the company has reduced costs significantly through lay-offs and factory closure. Lockheed Martin has also reduced the number of workers from 146,000 in 2008 to 116,000 in 2014. Moreover, the company has reduced its overhead costs thus increasing its profitability margins. Lockheed Martin Annual Report (2015) posits that the company closed its Goodyear factory and laid-off 600 workers in 2015.

Lockheed Martin has diversified its business by marketing its products on the global market. For instant, the company is boosting it sales of F-35 and F-16 fighter jets. The sale of these aircrafts means that the company will gain additional income through maintenance and repairs. The international market for Lockheed Martin’s products has increased from 14% in 2010 to 17% in 2014 (Ally, 2014). To ensure long-term sustainability, the company has ventured in unconventional areas such as the LMT contract to build a new facility that will convert waste products into energy. All these investments will help to offset the sequestration impact on revenues. Therefore, Lockheed Martin’s will remain profitable in the next few years.

According to Ally (2014), Lockheed Martin is creating value for shareholders by paying high dividends. The most appealing aspect of Lockheed Martin is management commitment to returning about 50% of its cash flow to shareholders. This goal is achieved through share buyback and paying high dividends. Lockheed Martin always pays dividends to its shareholders which have caused its share prices to increase significantly. From 2003, Lockheed Martin’s dividends have increased by about 52% in 2013. For instance in 2013, the company paid $1.5billion in dividends which was a 15% increase compared to 2012. In 2014, the company paid $6 per share which was a 13 percent increase compared to 2013 (Ally, 2014). The increasing dividends have caused its earnings per share to improve to 3.4% which is the highest compared to other defence companies such as Boeing, Northrop Grumman, and General Dynamics. To ensure a continuous increase in dividends, the company has a share buyback program to repurchase issued shares. For instance, in 2013, the company repurchased 16.2 million shares for $1.8 million. In 2014, it repurchased 7.8 million shares for $1.2 billion. This program is expected to continue in the near future. This is an indicator that management expects sales to increase in the next few years which will also cause an increase in dividend yield (Banerjee & De, 2015). Although the sequestration has a negative impact on Lockheed Martin’s profitability, its increasing business diversification program will be able to support high dividends. Therefore, investors should buy Lockheed Martin’s shares.

7.0 Method of raising and deploying financial resources

There are different methods that can be used to raise capital for businesses. For instance, Lockheed Martin can issue debenture or shares to raise capital. Depending of the existing circumstance in the business, Lockheed Martin can raise financial resource through debt capital or by issuing shares. Lockheed Martin raise financial resources through common stock, retained earnings and long term debt capital. Table 9 shows the sources of financial capital for Lockheed Martin.

Table 9:

Debt

shares

Retained earnings

$956

$303

$14,238

Most firms use a combination of debt and equity to ensure an equilibrium capital structure. However, the two sources of finance have their own advantages and disadvantages. For instance, one of the principal advantages of debt capital is that there is no legal obligation to repay the capital. Thus, it allows businesses to have extra capital that can be used to finance new projects in a firm (Campbell & Brown, 2015). Lockheed Martin has a choice to seek either debt capital or equity, depending on which source is easier to acquire. These two models of raising financial resources can be obtained from debt to equity ratio. This ratio shows the proportionate of assets of a firm financed by fix return capital compared to owners’ equity. The main advantage of equity capital is that Lockheed Martin has no obligation to repay its shareholders. However, shareholders invest their capital in a company so that it can be successful to earn them returns in terms of dividends (Campbell & Brown, 2015). However, even dividends payment is not a legal obligation that a company owes its shareholders. Firm pay dividends as a way of repaying shareholders for accepting to invest their capital in risky business rather than risk-free T-bill (Lavelle, 2004). Many companies, including Lockheed Martin, prefer equity finances because it places no additional financial burden to the company because there are no required monthly payments. However, the cost associated with equity finance is higher than debt capital. Issuing new shares causes ownership dilution which also reduces the earnings per share.

Debt finance is the second option which is used by Lockheed Martin to raise financial resources. However, the major challenge of debt capital is that it comes with certain restrictions on the activities of a firm. In 2015, Lockheed Martin had a long-term debt finance of $956m. Although debt finance requires a fix return at the end of each month, it is cheaper than equity finance. The major challenge with equity finance is the cost and requirement to issue shares. For instance, before a company issue shares, it has to develop a prospectus and follow many legal requirements which make is expensive. However, Corey, Ying, and David (2015) highlighted that issuing debenture has little legal requirement. A relatively low debt to equity ratio is preferred because it is attractive to debt financiers in the event a company intends to raise external source of capital. From the liquidity table (Table 9), Lockheed Martin has a debt to equity ratio of 4.61 which is relatively high compared to the previous years. This is an indication that a big proportion of its assets are financed by debt capital. The challenges with a high debt to equity ratio are a higher probability that the company will not be able to meet its obligations when they fall due. Since debt finance is a legal obligation of the company, it might be forced to go into receivership, thus, jeopardising the interest of investors.

According to Charalambakis and Psychoyios (2012), firms utilise debt capital because they are beneficial to their capital structure. Lockheed Martin uses debt finance when constructing its capital structure to lower financing cost. In addition to being cheaper than equity, debt capital has many advantages despite critics arguing that it increases financial risk and bankruptcy risk. Debt capital helps Lockheed Martin to increase return on equity by enabling the firm to achieve additional revenues. In fact, it lowers the cost of raising finances. Therefore, many companies include debt capital in their capital structure to lower financing cost. Since paying debt is a legal obligation of the company, debt holders bear less risk compared to shareholders who have no recourse in case a company fails (McFall, 2007). Moreover, during liquidation, debt holders have an upper hand claiming right to asset which adds another layer of protection for their investment. Debt finances increases management accountability and efficiency since a company has to meet its obligations. These obligations compel managers to be more aggressive in term of new and profitable investments. Moreover, it helps a business to retain more profits in the business to repay its obligations. For example, Lockheed Martin has high-retained earnings of $$14,238 (Lockheed Martin, 2014). This figure represents a significant part of profit not distributed to shareholders. Thus, using debt capital requires profits to be shared between debt holders and owners’ equity. However, when using debt capital, a company is only required to pay interest and principal (Kazmierska-Jozwiak, Marszałek,& Sekuła, 2015).

Using equity finances requires a company to pay dividends depending on the amount of profit made. When a company makes high profits, it has to pay a higher proportion of its profits to shareholders. This notion is also evident in Lockheed Martin; in 2015, the company, as mentioned earlier, used debt capital and retained earnings to finance acquisition of Sikorsky Aircraft which is one of the leading military helicopter manufacturers at $9.0 billion. Lockheed Martin often uses debt capital to finance its operations because it can be able to make ongoing monthly interest payment, thus, it can retain the rest of its profit without diluting its shareholdings.

8.0 Is Lockheed Martin’s shares a buy or sell?

This question is one of the most essential questions investors have to ask themselves. Before making this decision, investors have to consider the financial performance of the company and long-term profitability. Lockheed Martin is ranked as one of the best companies in the defence industry. However, the company lies on more than 80 % of its revenues from the U.S government contract. For instance, in 2013, the company obtained 79% of its revenues from U.S military contracts. Therefore, the long-term profitability of the company relies on defence spending. The U.S government under the Budge Control Act has reduced defense spending by $500billion. Ally (2014) noted that this is a significant potential source of revenue for Lockheed Martin and other companies in the defence industry. Therefore, the company cannot manage to pay its shareholders high dividends. Moreover, from the ratio analysis, Lockheed Martin is highly geared which increases financial risk of the company going into liquidation. Investors have to be cautious when buying these shares, considering that the overall global defence spending has also been declining. For example, Canada has scrapped the F-35 purchases due to the malfunctions reported on the fighter jet (Ally, 2014). This is an indication that the company’s profitability will continue to shrink in the near future due to loss of defence contracts. Lockheed Martin’s efficiency ratios have also been declining, an indication that the company is not utilising its assets efficiently to generate revenues. Therefore, investors should not buy Lockheed Martin’s shares. Investors who hold the shares should consider selling the shares to avoid future losses.

9.0 Conclusion

Lockheed Martin is a global aerospace and defence company which is recognised worldwide. The company was formed as a result of a merger between Lockheed Corporation and Martin Marietta. It obtains about 80 percent of its sales from military sales which receive nearly 10 percent of its budget from the Pentagon. Lockheed Martin is maximising the wealth of shareholders by issuing high dividends. Shareholders expect that equity raised by Lockheed Martin should be used to generate revenues. These revenues are then declared to the shareholders as dividends. However, in 2014, Lockheed Martin reported a 1 % decline in revenue in its first two quarters. Overall, earnings grew by 3% which was strongly supported by a 5 % increase in sales in the Aeronautics division. The decline in sales during 2014 financial year was associated with the current financial crisis and reduction in demand for Space Systems and information System segments. In the long term, Lockheed Martin revenues is likely to decline due to decreasing military budget where the company obtains more than 80 percent of its revenues. Therefore, investors should not buy Lockheed Martin’s shares.