Fitch Affirms Lockheed Martin at 'A-'; Revises Outlook to Stable
Fitch Ratings has affirmed Lockheed Martin Corporation's (LMT) 'A-'and 'F2' ratings and has revised the Rating Outlook to Stable from Negative. These ratings cover approximately $7 billion of debt. See the full rating list at the end of this release.
The Outlook revision to Stable is based on Fitch's analysis that LMT has the ability to maintain its current credit profile if Sequestration continues beyond FY2013. This analysis assumes that LMT successfully reduces 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.
If the Sequester is eliminated or renegotiated, LMT's financial performance will likely be better than forecast, and its credit metrics could strengthen. Fitch believes that a renegotiation of Sequestration, either in the amount or timing of spending reductions, is possible, as illustrated by the recent FY2014 budget submission, which replaces Sequestration with $150 billion of reductions near the end of the planning period.
The Outlook revision is also supported by Fitch's expectation that LMT's significant pension deficit will not have a large negative cash impact over the next two to three years due to large Cost Accounting Standards (CAS) pension recoveries. During that timeframe, LMT could experience a positive cash flow impact due to higher CAS pension recoveries compared to the minimum required cash pension contributions. Cash deployment to shareholders had been a concern incorporated in the previous Negative Outlook, but share repurchases fell $1.5 billion in 2012, and LMT put $3.6 billion into its pensions, including a $2.5 billion discretionary contribution in the fourth quarter.
LMT's performance in the past year also supports a Stable Outlook. Despite a difficult DOD spending environment, LMT's 2012 performance included higher revenues, higher margins, solid cash generation, and strong orders. Additionally, the F-35 Joint Strike Fighter program achieved several milestones in 2012 and the first quarter of 2013, although some uncertainty remains about the program's future production schedule and costs.
LMT's ratings are supported by the company's position as a leading defense contractor; high levels of defense spending; solid liquidity and cash generation; financial flexibility; increasing international sales; strong support of LMT's programs in the proposed fiscal 2014 DoD budget; significant awards in 2013; successful cost reduction efforts; and a large backlog.
Concerns include high U.S. government budget deficits; continued uncertainty in the DoD spending Outlook, including with regard to sequestration, which is expected to reduce the proposed fiscal 2014 DoD budget by approximately 10% (unless averted by legislative efforts); the large pension deficit and its impact on cash flows beyond 2016; a cash deployment strategy focused on returning the majority of free cash flow to shareholders; some modest program concentration; and execution on a few programs.
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 a concern, in addition to concerns about the commitment of several international partners to the program.
Key Rating Drivers:
The company's liquidity as of March 31, 2013 was $4.6 billion, consisting of $1.5 billion of credit facility availability (expiring in August 2016) and $3.1 billion in cash and cash equivalents. Fitch expects cash levels could decline by the end of the year due to tax payments and pension contributions, but overall liquidity should still be solid. The company has a favorable debt maturity schedule, with the next maturities in 2016 (totaling $951 million). The company retired $150 million of maturing debt in April of 2013.
LMT again generated strong cash from operations (CFO) in 2012 ($5.2 billion before $3.6 billion of pension contributions, or 10.9% of revenues), but the amount was down compared to 2011 ($6.5 billion before $2.3 billion of pension contributions, 14.1% of revenues) because of working capital movements, as expected. CFO was very strong in the first quarter of 2013 ($2.1 billion versus $458 million) because of a tax refund, working capital, and lower pension contributions.
Free cash flow (CFO less capital expenditures and dividends) was $1.8 billion in 2012 before discretionary pension contributions, compared to $2.2 billion in 2011. Fitch expects CFO will be fairly steady in the next few years, but free cash flow will likely decline because Fitch expects LMT to continue increasing its dividend.
LMT's goal is to return at least 50% of free cash flow (CFO less capex) to shareholders, but in 2009 to 2011 dividends and share repurchases exceeded FCF. Cash deployment before pension contributions moderated in 2012, as share repurchases fell to $990 million from $2.5 billion in 2011. LMT bought back approximately $8 billion of stock since the start of 2009, and dividends are now approaching $1.5 billion annually as a result of steady increases. Fitch's ratings incorporate expectations for continued share repurchases but with amounts at or below 2012 levels. Fitch expects dividends and pension contributions to be LMT's priority uses of cash in the coming years.
LMT's leverage (gross debt-to-EBITDA) for the latest 12 months period (LTM) ending March 31, 2013, was 1.24 times (x) compared to 1.28x, 1.32x and 1.0x in 2012, 2011, and 2010. EBITDA margin was 12.3% in the LTM, up from 12% in 2012 and 11.4% in 2011. Fitch believes margins could trend lower in the next few years excluding pension primarily due to revenue declines as well as growth on the F-35 program as it progresses through development and low rate initial production phases. However, non-cash pension expense should help reported margins, and successful cost reduction actions should help to limit the impact of revenue pressures.
LMT has one of the largest underfunded pension positions in Fitch's corporate portfolio, standing at $15.1 billion as of the end of 2012. The company's pension plans are 67% funded based on a projected benefit obligation of $46 billion (calculated on a GAAP basis), but the pension plans were over 90% funded on an ERISA basis. Non-cash pension expense has been significant in the past few years ($830 million in 2012, down from $922 million in 2011), but a downward trend should accelerate in 2013, with an estimated non-cash expense of $485 million.
LMT made $3.6 billion of pension contributions in 2012, including the $2.5 billion discretionary payment in the fourth quarter, and it forecasts that it will make $1.5 billion of contributions in 2013. Partially mitigating the cash impact of the pension contributions is the fact that pension costs are generally allowable costs in government contracts. LMT expects pension recovery under Government Cost Accounting Standards (CAS) in 2013 will be approximately $1.5 billion, netting out the company's expected pension contribution. LMT's required contributions should trend down temporarily in the next few years due to the higher discount rates allowed under MAP-21, while at the same time CAS recoveries should rise, leading to a potential situation after 2013 in which pension cash flows have a positive impact on LMT's cash from operations. Also, LMT had approximately $8 billion of CAS prepayment credits as of the end of 2012, the result of past contributions above CAS recoveries.
Fitch may consider negative rating actions in the event of sharper than expected declines in U.S. 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 aggressive cash deployment actions leading to higher leverage.
Fitch does not anticipate an upgrade in LMT's ratings because of the current uncertainty in the defense spending outlook, the company's large pension deficit, and Fitch's expectation that higher than expected cash flows would likely be deployed to shareholders.
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 revised to Stable from Negative.
Applicable Criteria and Related Research:
--'2013 Outlook: Global Aerospace and Defense' (Dec. 21, 2012);
--'Corporate Rating Methodology' (Aug. 8, 2012).
Applicable Criteria and Related Research:
2013 Outlook: Global Aerospace and Defense
Corporate Rating Methodology
Brian Bertsch, New York, +1-212-908-0549
Craig D. Fraser, Managing Director, +1-212-908-0310
Fitch Ratings, Inc.
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New York, NY 10004
David Petu, CFA, Director, +1-212-908-0280
Stephen Brown, Senior Director, +1-212-368-3139
Additional information is available at 'www.fitchratings.com'