Tickers in this Article: LMT, NOC, RTN, LLL, ATK
Defense giant Lockheed Martin (NYSE:LMT) reported second quarter earnings on Tuesday that demonstrated it is doing just fine in a climate of reduced defense spending. Despite tougher sales trends, it is finding ways to boost profitability and this trend should continue going forward.

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Second Quarter Recap
Sales eked out 2.4% growth to $11.6 billion. Two of four operating divisions posted sales growth. The largest is electronic systems that accounted for 32.5% of the total top line and grew 6.3% on increased sales for a number of air defense programs. Aeronautics weighed in at nearly 30% of sales and increased 8.9% on higher work volume related to the F-35 aircraft and C-5 airlifter. The decliners included information systems (20.4% of sales) and space systems (17.4%), which saw sales fall 6.4% and 3.3%, respectively.

Segment operating profit advanced 5.9% to $1.3 billion as every unit except information tech logged a double digit operating margin. Total company operating profits fell 11.8% to $984 million when backing out corporate overhead expenses. Lower interest and income tax expense pushed net income to improve by 10% as net earnings fell to $742 million. Share buybacks helped further as earnings per diluted share rose by 11% to $2.14.

For the full year, management expectations are currently calling for sales between $46 million and $47 million, which would result in operating profits of slightly over $3.9 billion, and earnings in a range $7.35 and $7.55 per diluted share. Both represent increases from previous guidance made in April. It also expects operating cash flow around $4.2 billion.

The Bottom Line
With projected capital expenditures of $850 million, or at the mid-point of capex over the last three years, Lockheed should report free cash flow in the neighborhood of $3.4 billion, or $9.66 per diluted share, based on current shares outstanding. At the current stock price, this represents a free cash flow multiple of less than 8.

Rivals including Raytheon (NYSE:RTN), L-3 Communications (NYSE:LLL), Northrop Grumman (NYSE:NOC) and Alliant Techsystems (NYSE:ATK) also trade at low earnings and cash flow multiples as investors fret that growth in the coming decade will fall far below levels seen over the last 10 years. This was due to an increase in defense spending to fight terrorism and major military campaigns in Afghanistan and Iraq.

Yet despite what will be more challenging top-line trends going forward, Lockheed has managed to leverage low single-digit annual sales growth into annual profit growth of more than 14% over the past five years. This trend should continue and bolt-on acquisitions should help keep sales moving forward modestly, and all stocks are ideal hedges to future terrorist activity. Lockheed also boasts a current dividend yield of 3.7% and means there are a number of investment positives for investors considering buying the stock. (For additional stock analysis, see ConocoPhillips Is A Strong Buy.)

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