Fitch Rates Lockheed Martin's Exchange Notes 'A-'; Outlook Negative
NEW YORK -- December 14, 2012
Fitch Ratings has assigned an 'A-' rating to Lockheed Martin Corporation's
(LMT) planned issuance of approximately $1.3 billion of 4.07% senior unsecured
notes due 2042. The new notes, along with approximately $225 million in cash,
will be issued in exchange for approximately $1.2 billion of existing notes
maturing from 2023 to 2040 that are subject to the recently expired exchange
offer. The Rating Outlook is Negative. A full list of ratings follows at the
end of this press release.
Fitch's Negative Outlook reflects the combined risks to LMT's credit profile
--Pressure on U.S. government budgets;
--Cash contributions to fund the $13.3 billion pension deficit; --and the
company's cash deployment strategy.
Although the company's current credit metrics are adequate for the existing
ratings, Fitch's projected cash flow metrics weaken in scenarios incorporating
expected defense spending plans. LMT's debt levels have climbed $2.8 billion
in the past three years, with more than half the increase coming in 2011,
weakening the cushion at the current rating.
LMT's ratings are supported by:
--The company's position as a leading defense contractor;
--Strong liquidity; and
--U.S. government budget deficits and their impact on defense spending,
including the potential for an additional $500 billion of reductions to the
DOD budget starting in January;
--The large pension deficit and its impact on cash flows;
--A shareholder-focused cash deployment strategy; and
--Some modest program concentration.
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 is a concern.
The company's liquidity as of Sept. 30, 2012 was approximately $6.2 billion,
consisting of $1.5 billion of credit facility availability (expiring in August
2016) and $4.7 billion in cash and cash equivalents. Debt increased by
approximately $3.0 billion in the past three years, or nearly 70%, including
$1.4 billion in 2011. The company has a favorable debt maturity schedule
through 2015, with only $150 million maturing in April of 2013.
LMT's leverage (gross debt-to-EBITDA) for the latest 12 months period (LTM)
ending Sept. 30, 2012, was 1.2x compared to 1.3x and 1.0x at the end of 2011
and 2010, respectively, and interest coverage was 14.9x in the LTM compared to
14.9x in 2011 and 15.4x in 2010. LMT's EBITDA margin was 12.1% in the LTM, up
from 11.4% in 2011.
LMT continues generating strong cash from operations (CFO), reporting $6.2
billion before $2.1 billion of pension contributions or 13.1% of revenues for
the LTM ended Sept. 30, 2012, compared to $6.5 billion before $2.3 billion of
pension contributions, or 14.1% of revenues in 2011. LTM free cash flow (CFO
less capital expenditures and dividends) was $1.7, down from $2.2 billion in
2011. Fitch expects free cash flow in the next several years will decline
because of higher capital expenditures and working capital to support growing
programs, dividend increases, and continued pension contributions.
LMT's goal is to return at least 50% of free cash flow (CFO less capex) to
shareholders, but in each of the past three years dividends and share
repurchases have exceeded FCF. LMT bought back approximately $7.7 billion of
stock since the start of 2009, and dividends are now well over $1 billion
annually as a result of steady increases, including a 33% hike in late 2011.
Fitch's ratings incorporate expectations for continued share repurchases, but
amounts could be lower than the $2.5 billion spent in 2011. Fitch expects
pension contributions and dividends to be LMT's priority uses of cash in the
Pension contributions will continue to be a significant use of cash over the
next several years, in Fitch's view. LMT has one of the largest underfunded
pension positions in Fitch's corporate portfolio, standing at $13.3 billion as
of the end of 2011. The company's pension plans are 67% funded based on a
projected benefit obligation of $40.6 billion (calculated on a GAAP basis).
According to LMT, the pension plans were over 80% funded on an ERISA basis.
After $2.3 billion of pension contributions in 2011, LMT made $1.1 billion of
contributions year to date in 2012 and plans to contribute about the same in
2013. Partially mitigating the impact of the pension situation is LMT's
healthy cash flow before pension contributions and the fact that some pension
costs are allowable costs in government contracts. Pension reimbursement could
total $1.1 billion in 2012 and $1.4 billion in 2013.
U.S. government spending trends are key drivers of LMT's financial performance
given that the company generates most of its revenues (82% in 2011) from the
U.S. government, with the bulk (61%) coming from the Department of Defense
Fitch expects 2013 to be a challenging year for the U.S. defense industry.
U.S. defense spending has been on an upward trend for more than a decade, but
the fiscal 2013 budget represents a turning point. The budget request reflects
the Budget Control Act of 2011 ($487 billion of spending reductions over ten
years), and it contemplates a 1% decline in spending in FY2013 (excluding war
spending) to $525 billion. Fiscal 2013 Modernization Spending (procurement
plus research and development [R&D]), the most relevant part of the budget for
defense contractors, is down 4%, the third consecutive annual decline by
The overhang of potential automatic cuts beginning in early 2013 related to
the 'sequestration' situation, adds to the uncertainty faced by defense
contractors in the current environment. Approximately $500 billion of
additional automatic cuts to DoD spending are scheduled to take place
beginning in January 2013, bringing the ten year total reduction to nearly $1
trillion. Personnel and war accounts would be exempt from the sequestration
reductions, so the brunt of the cuts would fall on other accounts, including
the accounts most relevant to defense contractors, including procurement.
Sequestration is a large threat in the near term, but Fitch's base case is
that it will be avoided. However, DOD spending reductions are likely to be a
part of any deal that avoids Sequestration, and there is also the possibility
that only a temporary resolution is put into place.
LMT's largest program, the F-35 Joint Strike Fighter, accounted for 13% of the
company's revenues in 2011, and the program is in the midst of a significant
growth period, with probable double-digit annual growth rates over the next
several years. However, the program has undergone three restructurings in as
many years because of cost growth, work scope changes, and delays. The main
challenge for the program is the concurrent development and production.
Despite the restructurings, the program remains the DOD's largest, and is
still probably a credit positive for LMT going forward from a revenue
perspective. The DOD requested $9.2 billion in the FY2013 budget. The program
remains under tremendous scrutiny because of schedule changes and cost
Fitch believes the main risks to the program are LMT's margins and the
ultimate size of the program given fiscal pressures in the US and other
partner nations. Given the large number of likely orders from the U.S. and key
international partners, the recent announcement by Canada that it is
re-evaluating its F-35 purchase plans is not a credit issue at this time.
WHAT COULD TRIGGER A RATING ACTION
The Outlook could be revised to Stable in the event of better than expected
DOD spending trends, especially for LMT's main programs, cost cutting actions
or changes in cash deployment strategies to offset weaker defense spending, or
better than forecast cash flows. The ratings could be downgraded in the event
of sharp declines in US DOD spending that affect some of LMT's key programs,
execution problems on key programs, or more aggressive cash deployment
Fitch rates LMT as follows:
--Issuer Default Rating (IDR) 'A-';
--Senior unsecured debt 'A-';
--Bank facility 'A-';
--Short-term IDR 'F2';
--Commercial paper programs 'F2'.
The Rating Outlook is Negative.
Additional information is available at 'www.fitchratings.com'. The ratings
above were solicited by, or on behalf of, the issuer, and therefore, Fitch has
been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012)
Applicable Criteria and Related Research:
Corporate Rating Methodology
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Craig Fraser, +1-212-908-0310
One State Street Plaza
New York, NY 10004
David Petu, CFA, +1-212-908-0280
Brian Bertsch, +1-212-908-0549
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