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Lockheed Martin vs. Northrop Grumman: Which Defense Stock is a Better Buy?

With the U.S. government as their biggest client, U.S. defense contractors typically witness stable and predictable cash flows. Based on this premise, in the absence of unforeseen setbacks or policy hurdles delivered by the new Presidential administration, we expect leading defense stocks Lockheed Martin Corporation (LMT) and Northrop Grumman Corporation (NOC) to continue their momentum and pay healthy returns to shareholders. But let’s find out which of these stocks is a better buy now.

Lockheed Martin Corporation (LMT) and Northrop Grumman Corporation (NOC) are two of the world’s largest defense technology companies. They are engaged in the manufacture and integration of military technology systems worldwide. LMT operates through four segments: Aeronautics, Missiles and Fire Control, Rotary and Mission Systems, and Space. NOC operates through Aeronautics, Defense, Mission, and Space Systems.

The defense industry’s tight ties with the U.S. government have meant historically that defense companies generate predictable revenues and cash flows. Although the rollout of COVID-19 vaccines and the economy’s gradual reopening may very well jump-start growth, the defense industry is a sector that could contribute significantly to economic  growth in the absence of any major setbacks delivered by the new administration. That said, LMT and NOC are two of the fastest growing defense stocks with strong balance sheets that have the potential to generate steady returns in the long run.

LMT has gained 63.9% over the past five years, while NOC returned 64.1%. But which of these stocks is a better pick now? Let’s find out.

Latest Movements

Last month,  LMT appointed President and CEO James D. Taiclet as chairman of the board, effective March 1, 2021. The board also elected Gregory M. Ulmer, as executive vice president of Aeronautics. Their wide-ranging experience and impressive record of leadership should help LMT to grow and thrive.

LMT recently completed the assembly and testing of the Orion Artemis I spacecraft and has transferred possession to NASA's Exploration Ground Systems (EGS) team to prepare for its Moon mission later this year. This advancement should open the door to a new era of deep space exploration for the company.

This month,  NOC closed the sale of its IT services business to Peraton, an affiliate of Veritas, for $3.4 billion. The company plans  to use the sale proceeds to  retire debt and to  repurchase shares.

Also this month, the company entered  an accelerated share repurchase (ASR) agreement with Goldman Sachs to repurchase $2 billion of NOC’s common stock. Under this agreement, NOC will receive approximately 5.9 million shares that represent approximately 85% of the expected share repurchases.

Recent Financial Results

LMT’s net sales increased 7.3% year-over-year to $17.03 billion in the fourth quarter ended December 31, 2020. Its net earnings rose 19.6% from their year-ago value to $1.79 billion, while its EPS grew 20.6% year-over-year to $6.38. Its Space segment’s net sales increased 14% from the prior-year quarter to $3.24 billion.

In the fourth quarter ended December 31, 2020, NOC’s net sales increased 17% year-over-year to $10.21 billion. Its operating income under defense systems grew 22% from its year-ago value to $214 million, while its EPS rose 181% year-over-year to $1.97. However, the company’s adjusted free cash flow declined 13% from the prior-year quarter to $1.81 billion.

Past and Expected Financial Performance

LMT’s revenue and EPS have grown at  a CAGR of 9.4% and 55.6%, respectively, over the past three years. Also, the CAGR of the company’s free cash flow has been 46.2% over the same period.

Analysts expect the company’s revenue to increase 4.9% in the current quarter, and 3.6% next year. LMT’s EPS is expected to increase 3.8% in the current quarter and 6.5% the next year.

In comparison,  NOC’s revenue and EPS grew at a CAGR of 12.3% and 5.2%, respectively, over the past three years. The CAGR of the company’s free cash flow has been negative over the same period.

Analysts expect NOC’s revenue to increase 4.6% next year. The company’s EPS is expected to increase 6% in the current quarter, and 7.2% next year.

Profitability      

LMT’s trailing-12-month revenue is 1.8 times NOC’s . But NOC is more profitable, with a gross profit margin of 20.3% versus LMT’s 13.3%.

However, LMT’s ROE and ROA of 149.6% and 11.3%, respectively, compare favorably with NOC’s 32.9% and 6.2%.

Valuation

In terms of trailing-12-month p/e, NOC is currently trading at 15.63x, 13.4% higher than LMT’s 13.78x. Also, NOC is slightly more expensive both in terms of trailing-12-month EV/EBITDA (11.08x versus 10.47x) and trailing-12-month EV/Sales (1.65x versus 1.60x).

So, LMT is the more affordable stock.

POWR Ratings

Both LMT and NOC have an overall rating of B, which translates to Buy in our proprietary POWR Ratings system. The POWR Ratings are calculated by considering 118 different factors with the weighting of each optimized to improve overall performance.

Both NOC and LMT have a Growth Grade of C, which is consistent with their expected growth in earnings and revenues.

In terms of Value and Quality Grade, both NOC and LMT have a B grade, which is consistent with their lower-than-industry average p/e ratio, and higher-than-industry average EBIT margin.

Among the 69 stocks in the C-rated Air/Defense Services industry, LMT is ranked #7 while NOC is ranked #10.

Our POWR Ratings system has also rated both LMT and NOC for Momentum, Stability, and Sentiment. Get all LMT’s ratings hereClick here to see the additional POWR Ratings for NOC.

The Winner

While both LMT and NOC can be considered good long-term investments based on their market dominance and major contributions in the defense industry, LMT appears to be a better buy based on the factors discussed here. LMT’s relatively lower valuation and higher profitability should help the stock perform better in the long run.

Our research shows that the odds of success increase if one bets on stocks with an Overall POWR Rating of Buy or Strong Buy. Click here if you want to know about other top-rated stocks in the Air/Defense Services industry.

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LMT shares were trading at $336.25 per share on Wednesday morning, up $1.22 (+0.36%). Year-to-date, LMT has declined -5.28%, versus a 4.43% rise in the benchmark S&P 500 index during the same period.



About the Author: Imon Ghosh

Imon is an investment analyst and journalist with an enthusiasm for financial research and writing. She began her career at Kantar IMRB, a leading market research and consumer consulting organization.

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