Pat McKeough responds to many requests from Members of his Inner Circle for specific stock tips well as questions on investment strategy and the economy. Every week, his comments and recommendations on the most intriguing questions of the past week go out to all Inner Circle Members. And each week we offer you a report on one of the stocks profiled in these Q&A sessions. We give you Pat’s buy-hold-sell recommendation as well as his analysis of the stock. This is part of the specific buy, hold and sell advice we offer you in our daily posts. Every week you get “A Stock to Sell” on Monday, “Best Canadian Stocks” on Tuesday, and “U.S. Stock Picks” on Thursday.

Recently we had a question from an Inner Circle Member about the biggest defense contractor in the U.S., and the world, Lockheed Martin. Well-known for its fighter jets, Lockheed also supplies many more defense needs, including rockets and satellites, missiles and information systems. Pat looks at the company’s financial results and its expanding program of share buybacks. He also assesses the risk of depending heavily on military budgets against possible shifts in U.S. government policy.

Q: Pat: What is your opinion on Lockheed Martin Corp.? Thanks.

A: Lockheed Martin Corp. (symbol LMT on New York; www.lockheedmartin.com) is the world’s largest defence contractor. In 2013, the U.S. government supplied 82% of its revenue.

Lockheed has five divisions:

• Aeronautics (32% of revenue) makes and services military aircraft, including the F-16, F-22 and F-35 fighter jets, as well as C-130 transport planes;
• Space Systems (18%) makes rockets and satellites;
• Information Systems and Global Solutions (18%) offers data and audio/visual communication systems for governments and corporate clients;
• Missiles and Fire Control (17%) makes ballistic missiles and laser-guided bombs, as well as control systems for nuclear-powered vessels and nuclear plants;
• Mission Systems and Training (15%) offers control systems for military aircraft and ships. It also makes flight simulators and other training gear.

In the three months ended September 28, 2014, Lockheed’s revenue fell 2.1%, to $11.1 billion from $11.3 billion a year earlier. That’s mainly because the U.S. government has cut defence spending in response to its rising budget deficit. However, an increase in commercial satellite launches raised the Space Systems division’s revenue by 4.0%.

Lockheed continues to expand share buybacks

Thanks largely to savings from a recently announced restructuring, which includes closing plants and cutting 3% of its workforce, Lockheed’s earnings rose 5.5%, to $888 million from $842 million a year ago. The company spent $446 million on share buybacks in the latest quarter. As a result, earnings per share gained 7.4%, to $2.76 from $2.57.

Lockheed’s long-term debt of $6.2 billion is a low 10.3% of its market cap. It also holds cash of $3.0 billion, or $9.38 a share.

The company recently added $2.0 billion to its share repurchase authorization. It can now buy back up to $3.9 billion worth of shares, which is equal to 6.6% of its market cap. There are no time limits for these repurchases, but Lockheed intends to buy back $2.0 billion of shares in 2015.

The company has also increased its quarterly dividend by 12.8%, to $1.50 a share from $1.33. The new annual rate of $6.00 yields 3.2%.

Lockheed’s outlook is positive. But its reliance on military spending, especially from the U.S., is a big risk factor. After all, this spending can rise or fall abruptly in line with unpredictable shifts in U.S. politics and world military developments.

Problems with the development of the F-35 fighter jet also add uncertainty. However, the plane will be a cornerstone of the U.S. military for years to come. In addition, Lockheed plays a major role in many other key U.S. military programs.

The stock trades at just 17.0 times the company’s forecast 2014 earnings of $11.20 a share.

We view Lockheed Martin as a hold.