Why LMT’s Capital Allocation Is Unlikely to Disappoint Investors



Lockheed Martin’s capital allocation in 2Q16

Lockheed Martin (LMT) managed to generate $1.5 billion in cash from operations despite the fact that the recovery of cash associated with the Lot 9 and Lot 10 of F-35 fighter jets (PPA) is still stuck in negotiation. The company utilized $235 million for capital investments and generated $1.2 billion in free cash flows in 2Q16. Lockheed Martin allocated 81% of its free cash flows towards dividends and share repurchases. $501 million each were used to distribute dividends and repurchase shares.

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Spin-off and returns from share repurchases

In January 2016, Lockheed Martin unveiled its plan to shed its Information Systems and Global Solutions segment and merge it with Virginia-based Leidos Holdings (SAI) in a $5 billion Reverse Morris Trust transaction. The Reverse Morris Trust is a type of transaction in which the parent company completes a spin-off of a subsidiary and then merges it with a target company to create a merged new entity. The transaction is tax-free if the subsidiary is the buyer of the target company and owns more than 50% of the merged company.

The company is slated to receive a special cash payment of $1.8 billion as a result of the transaction and it intends to use these proceeds to reduce its share count by 10 million shares to offset the dilution from the spin-off.

Investments in cost saving initiatives

In the Farnborough Air Show last week, the company announced a two-year extension of cost saving initiatives to reduce the lifecycle costs of F-35 by $4 billion as it ramps up the production of the F-35 fighter jet (XAR). The company has also announced an initiative to reduce sustainment costs by 10% by initiating projects such as block buys of spare parts. These are expected to yield cost savings of $1 billion over a five-year period.

Key ETFs

Investors interested in trading in the aerospace and defense sectors could look into the SPDR S&P Aerospace & Defense ETF (XAR) and the PowerShares Aerospace & Defense Portfolio (PPA). Major holdings in PPA include Lockheed Martin (LMT), General Dynamics (GD), and Boeing (BA), which have weights of 6.9%, 6.5%, and 6.1%, respectively.


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