Investing in Defense Stocks: Why Lockheed Martin (LMT) Is Too Big to Fail

Last year when Congress formed its much-lauded "Supercommittee" to sort out America's debt crisis, there was a lot of handwringing about draconian budget cuts.

But true to form, on the eve of an election year, our politicians did nothing and the sequestration clock began to tick.

In essence, they made the bold move to kick the can down the road.

The problem is if the clock is allowed to keep ticking, those same draconian cuts will happen anyway.

No industry is more aware of this than the defense sector.

For them it is literally like turning a battleship – the major players need a lot of lead time to readjust their bearings.

So it's no surprise that the defense sector, which has a budget bigger than the combined defense budgets of at least the next 30 countries in the world, is worried more than most about significant cuts.

And when corporate execs worry, so does Wall Street.

But somehow, I think the military industrial complex will survive. For investors, it will be all about picking the right players.

Investing in Defense Stocks: Lockheed Martin's Big Advantage

One of them is Lockheed Martin (NYSE: LMT).

As the great military strategist Sun Tzu once said, "Opportunities multiply as they are seized."

Today, there is no company better at seizing opportunities than Lockheed Martin.

Of the $40 billion or so in annual revenue LMT brings in, $36 billion of it is government contracts, with the lion's share being defense contracts.

That proportion is 25% larger than its closest competitors like Boeing (NYSE: BA) and Northrop Grumman (NYSE: NOC). Think of it as the Citibank (NYSE: C) of defense contractors, with all the "too big to fail" implications therein.

Lockheed has become a de facto quasi-governmental agency unto itself.

As such, Lockheed has the ability to go to Congress and ask them to find ways to keep the battleship of defense on the most direct path forward.

Having this kind of influence is highly beneficial for a company, and LMT's stock price has actually been rising since last fall-even under the threat of budget cuts.

In fact, recently Congress quietly passed a bill that would exempt defense programs from the inevitable cuts that would come to pass if sequestration is activated Jan. 2, 2013.

That allows the big contractors like Lockheed to focus on business as usual.

In LMT's case, sales of the next generation F-35 fighters are on schedule, as are the orders for the Navy's Littoral Combat Ships. Its Joint Light Tactical Vehicle (JLTV) is also still in the running to replace the Humvee.

Simply put, air, space, sea or land, LMT has a hand in almost every major defense project in the field and on the drawing board.

Lockheed Martin is Too Big to Fail (LMT)

LMT has also branched out from defense and now works with other federal agencies like the IRS and Postal Service. The company also builds and services sensors and monitoring equipment (i.e. speed cameras and surveillance equipment) for state and municipal governments.

It is a rock solid company with one of the world's best customers as its chief client … and it pays a nice 4.5% dividend to boot.

What's more, new rules out by Congress are going to help make life even better for LMT.

Here's why.

"Bundling" is the new watchword for government contractors and it has some big implications.

Previously, a small contractor could bid on a small piece of a larger contract where it might have specific expertise. This allowed boutique firms to flourish.

Now, the contracts are all bundled and smaller contractors need to work with the prime contractor for their piece of the work.

From the government's side, this saves a lot of money and time working through all the contract proposals.

But from the small contractor's side, it means they are shut out of big contracts. The smaller players don't have the size to operate as a prime contractor and the prime contractors can squeeze the profit margins of the subcontractors and keep more profits for themselves.

While bundling certainly engenders some pity for the small contractors, for prime contractors like LMT, this is another source of long-term revenue growth if the era of shrinking defense budgets actually occurs.

But I have my doubts.

LMT is a great long-term total return play as the cornerstone of U.S. defense.

Stop worrying and learn to love the military industrial complex.

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