Lockheed Martin: A Long-Term Play on Defense Spending Despite ROCE Headwinds

Lockheed Martin (LMT) operates in an era of unprecedented defense spending, fueled by geopolitical tensions and modernization priorities. While its Return on Capital Employed (ROCE) has shown signs of stagnation, the company's robust contract pipeline, strategic positioning in hypersonic defense, and dividend resilience argue for it as a compelling long-term holding. Here's why investors should look past near-term valuation concerns.

A Pipeline of Multi-Billion-Dollar Contracts

Lockheed's backlog of defense contracts, now exceeding $173 billion, reflects its dominance in high-priority sectors like missile defense, space systems, and F-35 sustainment. Key wins in 2024–2025 include:
- $2.97 billion for modernizing the Aegis Ballistic Missile Defense system, critical for countering hypersonic threats.
- $1.00 billion for the Conventional Prompt Strike program, a cornerstone of U.S. hypersonic capabilities.
- $3.23 billion in JASSM/LRASM missile sales to allies like Japan and Poland.

These contracts span 5–10 years, ensuring steady revenue visibility through 2030. The company's $3.3 billion in new Q2 2025 contracts alone underscores its ability to capitalize on defense spending surges.

Geopolitical Tailwinds and Structural Demand

The "One Big Beautiful Bill Act" (OBBBA) allocated $150 billion in incremental defense spending through 2027, directly benefiting Lockheed's core programs. With Russia's invasion of Ukraine, China's military modernization, and North Korea's missile tests, global defense budgets are expected to grow at ~4% annually. Lockheed's $6.3 million contract to equip Poland's Apache helicopters exemplifies how regional instability drives demand for U.S. systems.

Dividend Resilience Amid Margin Pressures

While Lockheed's net income fell 22.89% in 2024 due to rising costs, its $5.29 billion in free cash flow remains robust. The dividend—$3.30 per share annually—is supported by a conservative 55.5% payout ratio, leaving room for growth even as ROCE has dipped to 9.87%.

Addressing ROCE Concerns: Investment Over Efficiency?

ROCE has declined from 12.6% in 2020 to 9.87% in 2024, reflecting rising capital intensity in programs like the Next Generation Interceptor (NGI). However, this is a trade-off for long-term growth:
- Hypersonic Defense: The NGI program, valued at $17 billion, requires upfront investment to counter emerging threats.
- Space Dominance: Contracts like the $2.27 billion NOAA GeoXO satellites reflect growing demand for space-based surveillance.

These programs align with Pentagon priorities, ensuring sustained funding. While ROCE may stay subdued in the near term, $20+ billion in annual defense budgets for hypersonic and missile systems suggest capital allocation will eventually yield returns.

Valuation: Undervalued Relative to Growth Prospects

Lockheed's P/E ratio of 17.3x is below its five-year average of 18.5x, despite a backlog-to-revenue ratio of 2.4x (indicating strong future growth). Analysts project revenue to climb to $84.85 billion by 2029, with EPS expanding to $31.62—supporting a 14.32x P/E by 2029.

Risks and Considerations

• Execution Risks: Delays in hypersonic programs or cost overruns could pressure margins further.
• Geopolitical Volatility: A sudden reduction in defense spending or trade restrictions on arms exports could disrupt backlog growth.
• Margin Recovery: The company must stabilize margins beyond 9.87% to justify its valuation fully.

Investment Thesis: A Hold for the Long Run

Lockheed Martin's $173 billion backlog, strategic alignment with hypersonic and missile defense priorities, and dividend resilience make it a compelling long-term hold despite near-term ROCE challenges. Investors should view dips in its stock price—currently trading at $380/share—as opportunities to accumulate.

While peers like Raytheon (RTX) and Northrop Grumman (NOC) also benefit from defense spending, Lockheed's leadership in foundational systems (F-35, Aegis, GPS satellites) gives it an edge in stability. The company's $5.29 billion free cash flow in 2024 and $17 billion NGI contract signal a path to margin recovery.

Final Take

Lockheed Martin is not a "high-growth" stock, but it is a defensive play in a high-defense-spending era. With geopolitical risks and modernization spending acting as tailwinds, its robust backlog and dividend stability outweigh near-term ROCE headwinds. Investors seeking exposure to U.S. defense priorities should consider adding LMT to their portfolios for the long haul.