NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings for Lockheed Martin Corporation (LMT) at 'A-/F2'. The Rating Outlook is Stable. The ratings cover approximately $7 billion of debt. A full list of ratings follows at the end of this press release.
LMT's ratings are supported by the company's position as a leading defense contractor; solid liquidity and cash generation; financial flexibility; increasing international sales; support for LMT's programs in the proposed fiscal 2015 DoD budget; successful cost reduction efforts; and a large backlog.
Concerns include continued uncertainty in the DoD spending outlook, including with regard to sequestration after FY2015; a cash deployment strategy focused on returning the majority of free cash flow to shareholders; rising competitive pressures in parts of the space sector; the large pension deficit; and some modest program concentration.
Fitch believes the F-35 Joint Strike Fighter will likely be a long-term credit positive for LMT, but near term uncertainty about its schedule and costs remains, in addition to concerns about the commitment of several international partners to the program. The program accounts for 16% of LMT's revenues and rising.
The Stable Outlook is based on Fitch's analysis that LMT has the ability to maintain its current credit profile if sequestration continues beyond FY2015. This analysis assumes that LMT continues reducing costs in line with revenue declines, continues to grow its international and adjacent area sales, and does not increase leverage through cash deployment actions. Fitch's projections of LMT's financial metrics in this sequestration scenario will still be consistent with a weak 'A-' rating.
KEY RATING DRIVERS
LMT's performance in the past year supports the ratings and outlook, with LMT's overall financial performance in 2013 exceeding Fitch's expectations. Despite an uncertain DOD spending environment which drove sales down 4%, LMT's performance included higher margins, good cash generation, an improved pension position, and solid orders. While the DOD environment remains difficult, there is more clarity through FY2015 than there was a year ago. The company also continues to grow its international backlog, providing some offsetting growth for DOD revenue declines.
LMT has proactively reduced costs over the past five years in response to defense spending pressures, helping margins rise in the face of revenue pressures. LMT has significantly reduced its headcount over these years from 146,000 to 115,000, and this will continue during 2014. The company has also reduced its facility footprint, eliminating approximately 7.2 million square feet since 2008; an additional 2.5 million square feet in reductions is still to come. The supply chain has also been the source of savings.
In 2013 segment operating margins rose 90 bps to 12.7%, and EBITDA margins rose 145 bps to 13.4%. In addition to cost reductions, pension expense and income have also helped margins. Fitch expects a continuation of rising margins over the next two years. LMT's leverage (gross debt-to-EBITDA) for the latest 12 months period (LTM)ending March 31, 2014, was 1.1x compared to 1.2x and 1.3x in 2013 and 2012.
The company's liquidity as of March 30, 2014 was $4.8 billion, consisting of $1.5 billion of credit facility availability (expiring in Aug 2016) and $3.3 billion in cash and equivalents. As of March 30, 2014, LMT held $425 million of its cash at its foreign subsidiaries, and it estimated the cash taxes due upon repatriation would not be significant. The company's debt maturity profile is favorable with no debt maturities until 2016 when $951 million of notes become due.
LMT again generated strong cash from operations (CFO) in 2013 ($6.8 billion before $2.25 billion of pension contributions, or 15% of revenues), and CFO was very strong in the first quarter of 2014 ($2.1 billion). Free cash flow (CFO less capital expenditures and dividends) was $2.2 billion in 2013. Fitch expects FCF will be fairly steady in the next few years, with higher net pension recoveries offsetting higher capex and dividends.
LMT's cash deployment has been focused on share repurchases and dividends, which is consistent with LMT's strategy of returning at least 50% of free cash flow (cash from operations less capital expenditures) to shareholders. Fitch's ratings incorporate expectations for continued share repurchases at or below FCF levels. Dividends now exceed $1.5 billion annually, and Fitch expects these to rise at double digit rates. LMT will likely continue to pursue acquisitions as a part of its overall business strategy, but Fitch expects these to be manageable within LMT's cash resources. If LMT were to pursue a larger acquisition, Fitch expects the company would reduce share repurchases.
LMT had a large pension deficit of $9.2 billion at the end of 2013, but it was down significantly from the $15.1 billion deficit in 2012. The pension plans are 78% funded on a GAAP basis (up from 67% funded at the end of 2012) and 90% funded on an ERISA basis. LMT anticipates making $1 billion of voluntary contributions in 2014, and Fitch expects this rate will continue for several years. Given government reimbursement of some pension costs, overall pension cash flows should be positive for the next several years as a result of past contributions by LMT. LMT had approximately $9.6 billion of prepayment credits as of the end of 2013.
LMT generated 82% of its 2013 revenues from the U.S. government, including 61% from the DoD. As a result, defense spending is a key driver of LMT's financial performance and credit quality. This revenue concentration is a risk, and it will remain high although international sales may become a larger part of overall sales. The risk is somewhat offset by the company's program diversification, large backlog, and length of program contracts. The strategic importance of F-35 program for the US and its allies remains a long-term strength of the company.
U.S. defense spending is projected to remain stable during fiscal 2014 and 2015 at the fiscal 2013 level driven by the Bipartisan Budget Act of 2013 which became law in late 2013.
Despite stabilization of the U.S. military spending budget, Fitch expects 2014 to be another challenging year for U.S. defense contractors. The sequestration cuts implemented in 2013 should have a negative effect on most defense contractors for the next several years because of the lag between appropriations and outlays and Fitch expects revenues of most defense companies will decline in fiscal 2014.
Lockheed Martin plans to mitigate the impact of sequestration and U.S. budgetary pressures by increasing its international sales. LMT is looking to grow international sales to at least 20% of its portfolio in the next several years. The expected international sales growth over the next several years should be driven by strong orders for existing products and the growth of F-35. In 2013 International sales totaled about $7.8 billion, or 17% of sales. Plans for growth are supported by the international order backlog, which accounts for 25% of LMT's overall backlog. Aircraft and missiles account for the majority of existing non-US sales, and Fitch expects this will continue with the growth of the F-35 and demand for missile defense systems.
Adjacent business areas are another potential source of growth. Energy, commercial cyber security, commercial satellites, commercial aircraft services, and sea-based products are focus adjacent areas for the company.
Fitch may consider negative rating actions in the event of sharper than expected declines in US DOD spending that affect some of LMT's key programs, execution problems on key programs (especially the F-35), unsuccessful attempts to reduce costs in line with revenue reductions, lower than expected international revenue growth, or debt-funded cash deployment actions. Sustained FFO Adjusted Leverage above 2.5x (taking into account discretionary pension contributions) could lead to a negative rating action.
Fitch does not an anticipate an upgrade in LMT's ratings because of the current uncertainty in the defense spending outlook, Fitch's expectation that higher than expected cash flows would likely be deployed to shareholders, and the company's large pension deficit.
Fitch affirms LMT's ratings as follows:
--Issuer Default Rating (IDR) at 'A-';
--Senior unsecured debt at 'A-';
--Bank facility at 'A-';
--Short-term IDR at 'F2';
--Commercial paper programs at 'F2'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014);
--'2014 Outlook: Global Aerospace and Defense' (Dec. 12, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
2014 Outlook: Global Aerospace and Defense (Commercial Aerospace Flies Higher, Defense in a Stalemate)