Lockheed Martin Corp., the top U.S. defense company, will post its first annual share price decline this year since 1999, erasing its premium over rivals' shares amid concern defense spending will fall and pension costs rise.
Lockheed's shares fell 12 percent through yesterday, the largest decline among all nine members of the Standard and Poor's 500 Aerospace and Defense Index, which rose 20 percent in the same period. The drop was worse than all but nine members of the Standard and Poor's 500 Index, which rose 26 percent.
Shares of Lockheed, which have commanded a price-to-earnings ratio at least 24 percent higher than any of the other top five U.S. defense companies in each of the past three years, were forced in line with rivals this year as investors grew concerned the premium was unwarranted.
"Lockheed could be considered the 'blue chip' stock of the defense industry, but one of the things that scared people off was the valuation," said Charles Dyreyes, an analyst at Glenmede Trust Co. in Philadelphia, which sold a third of its Lockheed shares in the third quarter. "The other companies have finally caught up."
Glenmede held 93,785 Lockheed shares at the end of September, after selling 47,848.
Bethesda, Maryland-based Lockheed's shares traded at 22 times earnings at the end of 2002, according to Bloomberg data. Northrop Grumman Corp., the third-largest U.S. defense contractor, had the next-highest ratio among the top five U.S. defense companies in 2002 at 16.
As of yesterday, Lockheed's ratio had dropped to about 19, falling behind fourth-largest Raytheon Co. at 21. Northrop's had increased to 19, as had second-biggest Boeing Co. General Dynamics Corp., the fifth-largest, had a ratio of 18.
Defense companies involved in commercial aviation, such as Boeing Co., the biggest airplane maker, and General Dynamics, which makes Gulfstream business jets, did better than the rest of the group amid expectations a decline in aircraft sales since the Sept. 11 terror attacks is poised to reverse, said Frank Giove, an analyst at Atlanta-based Trusco Capital Management.
Shares of Boeing have risen 28 percent so far this year, and General Dynamics gained 14 percent. Northrop and Raytheon have each fallen about 2 percent.
Lockheed spokesman Thomas Jurkowsky declined to comment for this story.
The poor performance of defense shares in general, and Lockheed in particular, came as a surprise because the U.S.-led invasion of Iraq and the need to keep U.S. troops supplied there was expected to give defense stocks a lift, Giove said.
In 2004, Trusco expects Lockheed and other defense stocks will "catch up," performing at least as well as the broader market, if not better, Giove said. Trusco bought almost 135,000 Lockheed shares in the third quarter, bringing its total to 3 million at the end of September.
"You look around the world today, and we're still in trouble; our security level is code orange," Giove said. "The defense companies, especially those that have a lot to do with intelligence, surveillance and reconnaissance equipment, are going to do well."
Shares of Lockheed had become "overpriced" in the past three years, JSA Research analyst Paul Nisbet said. They gained the most among the top five U.S. defense companies in each of the past two years, and more than doubled from 2000 through 2002.
Lockheed could be poised to rebound next year, said Nisbet, who rates the shares "buy" and holds them among his personal investments.
"Lockheed has done everything conceivable to merit a much better stock price," Nisbet said. "Huge increases in revenue, the acquisition of Titan Corp. and two increases in the dividend this year have all been to absolutely no avail. They've performed extremely well, but the stock certainly hasn't."
Sales at Lockheed rose 22 percent to $22.8 billion in the first nine months of the year. The purchase of communications- equipment maker Titan for $1.8 billion in cash and stock will add immediately to earnings when it closes in the first quarter, the company has said.
Rising pension expense is one issue that concerned investors. Lockheed's net income will more than double to $1.05 billion this year from $500 million last year, Nisbet said. Still, that's 18 percent less than the company would have reported if it weren't for pension expenses, he said.
The pension issue isn't unique to Lockheed and is one reason shares of Northrop and Raytheon are also down this year, Nisbet said.
Lockheed had $220 million of pension expenses in the first nine months of the year, compared with $169 million of income in the same period a year earlier. Northrop and Raytheon also had pension expenses in the same period.
Investors are also nervous about the outlook for U.S. defense spending amid record federal budget deficits, said Donald Coxe, chief strategist at Chicago-based Harris Investment Management, which sold most of its Lockheed shares. Harris held 16,877 shares as of Sept. 30.
"There is more of a sense (the military is) going to have to cut back on existing programs," Coxe said. "It makes it harder to do two- or three-year forecasts for (corporate) earnings and cash flow if you're afraid programs you thought were going to go for years and years are going to get cut."
Lockheed's backlog is heavily reliant on contracts for fighter jets, such as the F/A-22 and the Joint Strike Fighter, which concerns some investors, said Philip Finnegan, director of corporate analysis for the Teal Group, a consultancy in Fairfax, Virginia. In October, Lockheed said aeronautics programs accounted for $39 billion, or more than half, of its $74 billion backlog.
"If there is pressure on the defense budget, there is a danger" to the fighter programs, Finnegan said. "There is a history of stretching out and cutting back on these kinds of programs."
In October, Lockheed President Robert Stevens said he wasn't aware of any 'particular threat" to funding the $200 billion multinational Joint Strike Fighter program. In November, U.S. President George W. Bush and U.K. Prime Minister Tony Blair reaffirmed a "strong commitment" to the project.
Still, worry about funding for the fighter programs was one reason Integrity Asset Management LLC in October sold all the Lockheed shares it held as part of its $10 million under management, said Adam Friedman, senior portfolio manager.
"The concern with Joint Strike Fighter and F/A-22 is that the backlog is more ephemeral than people thought," Friedman said. "That was always in the back of my mind because it's a huge piece of their backlog and it's vulnerable."