The purpose of this essay is to provide a critical evaluation Lockheed Martin Corporation’s annual reports, in the recent five years.

The purpose of this essay is to provide a critical evaluation Lockheed Martin Corporation’s annual reports, in the recent five years. It essay shall compare Lockheed Martin Corporation with Northrop Grumman Corporation as its potential competing company in the same Industry. The essay encompasses Accounting and Finance Clusters with its numbers calculated through FinSas.

Industry background
The global commercial aerospace niche experienced strong revenue and operating earnings growth in the pasts during the last two years. This because there was demand for next-generation aircraft and growing passenger traffic, especially in the Asia-Pacific and the Middle East regions. On the other hand, the international demand for defence and military products was in high demand. The tensions in regions such as the Middle East, Eastern Europe, North Korea, and the East and South China Seas led to the increase in defence budgets. Globally, the US spends most of the global military products. This challenges Western Europe’s need for efficient and improved air transport system.

Company Information
Lockheed Martin Corporation was established in 1995. The company has offices in the Middle East, Europe, Oceania, and Asia with its main offices and manufacturing centre in the US. The company’s business strategy mainly focuses on research, design, development, manufacturing, integration and sustainable advanced technology systems, products and services of aerospace, defence and security. Lockheed Martin Corporation’s (‘Lockheed”) solves complex challenges through advanced scientific research and delivery of innovative solutions to customers. The company empowers customers to strengthening their own security and advance their scientific understanding through Lockheed’s value-added products and systems. Lockheed focuses on its core mandate; developing advanced technology systems and scientific discovery products to provide a clearer insight and improved security in the complex world of land defence.
Lockheed’s business strategy, focuses on providing world-class technology, products and services to its clients. The quality and technology of the company’s equipment have been proven with the US Department of Defence, US federal government agencies and through successful partnerships with numerous international government in worldwide.
Lockheed delivers a wide range of world-class products and services that enables customers safe from danger. This is achieved through the company’s devotion to the development and production of Aeronautics, Missiles and Fire Control, Rotary and Mission Systems and Space products. With its 97,000 employees worldwide the company has managed to achieve the following financial records;

Part One: Accounting Cluster Analysis

Liquidity ratios is an indicator of the cash mobilisation power of that allows Lockheed to meet short-term and long-term financial obligations. The liquidity of Lockheed is a measure of its financial stability (Gibson, 2012).

The liquidity ratios have current assets and current liabilities. The current ratio is calculated by dividing current assets (Assets that can be cashed within a year) against current liabilities (Liabilities to be paid within a year). This shows short-term debt payment capability. Therefore Current ratio is the most important ratio from the analysis of Lockheed credit review.

The Current Ratio

Figure 1. Trend analysis for Current Ratio for both of Lockheed and Northrop

It is evident from the graph that both companies have the current ratio figures of well below two which is considered the standard for many other industries. Lockheed’s current ratio remained nearly stable during past five years, apart from 2014 when it was only 1.11. According to Lockheed’s annual report 2016, there were decreased proceeds in 2014 from stock option exercises which increased cash used for financing activities. In addition, 2015 recorded the highest current liability. This is because there was primarily a result of the debt incurred to fund the Sikorsky acquisition.

The Acid Test Ratio
The acid test ratio is also called “quick ratio”. It is ratio of the sum of quick assets to current liabilities (Gibson, 2012).

Figure 2. Trend analysis for Acid Test Ratio for both of Lockheed and Northrop

The above ratio indicates that Northrop has more assets and better liquidity compared to Lockheed. It is therefore able to meet its obligations as opposed to selling off its inventories. Lockheed Martin’s current assets in 2016 were 30.9%, while Northrop’s stood as 11.9% of total. The net of cash acquired, acquisition of Sikorsky and aligning it under Lockheed’s Rotary and were responsible for the decrease in cash ratio in 2015. However, its working capital indicate that Lockheed is growing for every year over the past five years. The company recorded US$1,700 million in 2012. This constantly grew to US$2,566 million by 2016 with exemption of a little fall in 2015. Northrop has an unstable on acid test ratio, cash ratio and working capital over the last five years.

Figure 3. Trend analysis for Current Ratio, Acid Test and Cash Ratio

Figure 4. Trend analysis for Current Assets, Current Liability, Inventory and Working Capital

Long-term debt paying ability
Long-term debt ratios are a measure the long-term financial position of a company, including its ability to meet financial requirements for outstanding loans (Gibson, 2012).

Debt Ratio
Debt ratio is a measure of capital and equity. Lockheed’s average debt ratio in the last five years is 93.50%. Both the company’s liability and total assets increased. However, Northrop’s debt ratio is lower compared to Lockheed’s highest reached of only 79.47% in 2016. This means that Lockheed is at a higher risk and under pressure for on long-term liability than Northrop. Lockheed still has a larger market share and a wider business scope that may lead to higher revenues compared to Northrop.

Lockheed’s Debt/Equity ratio was extremely high. It struck its lowest percentage at 635.83% in 2013 and its highest at 99,020.51% in 2012. In contrast, Northrop’s ratio is much less than Lockheed’s. That means Northrop has a better liability situation than Lockheed.

Debt to tangible net worth ratio
In 2016, Lockheed’s intangible assets shared 31 % of its total assets while its cash shared a 33.6%. Therefore, its debt to tangible net worth ratio is completely different as its Debt to Equity ratio. One of the reasons why Lockheed has a negative net worth is because it acquired Sikorsky in 2015 which demanded that the company pays substantial tax liability. In contrast, Northrop’s intangible assets shared 54.31% of its total assets in 2016, while its cash shared only 20.14%. This led its debt to tangible net worth ratio of -235.24%. This is 113.41% higher than Lockheed’s -348.65%. Even if Northrop is higher, both companies have negative percentages.

Figure 5. Trend analysis for Total Assets, Current Liabilities, Long-Term Liabilities, Total Liabilities and Intangible Assets

Figure 6. Trend analysis for Debt Ratio, Debt/Equity and Debt to Tangible Net Worth

Profitability ratio demonstrates company’s measures of profit and loss. It analyses and reviews the cause of performance. It is therefore very important for investors and creditors (McLaney and Atrill, 2015).

Net Profit Margin
Lockheed’s net profit margin grew from 5.82% in 2012 to 7.94% in 2016. The company’s net sales, cost of goods sold, operating expenses flatted. However its operating income grew while other income avenues fluctuated within the same period. Northrop’s net profit margin stood at 8.98% in 2016. This was slightly higher than Lockheed. It indicated that competition and a transparent market prices in world weapons industry influenced Lockheed’s profitability.

Lockheed’s trend of gross profit margin during the last five years is similar to the trend of net profit margin that fluctuate from 8.89% in 2012 to 10.71% in 2016. This is more stable than net profit margin because it eliminates the effect from changing operating income. Northrop also kept growing from its 22.13% in 2012 to 23.57% in 2016.
Figure 7. Trend analysis for Net Profit Margin and Gross Profit Margin

Total Asset Turnover
Lockheed’s total asset turnover and return on assets fluctuated slowly from 2012 to 2016. The company’s total asset turnover and return on assets decreased from US$1.23 million to $0.99 million and from 9.75% to 7.85% respectively within 2014 and 2016. However, net sale, net income before minority share of earning and total assets increased during these years. The increased speed of net sales and net income before minority share of earning are less than the total assets. This is due to the company’s substantial tax liability due the acquisition of Sikorsky in 2015. In addition, fiercer competition makes Lockheed difficult to expand the market and make revenue and profit than before. Northrop’s net sales and total asset decreased. Its net income before minority share of earning increased compared to Lockheed within the same period.

Figure 8. Trend analysis for Total Asset Turnover and Return on Assets

Lockheed’s ratio of sales to fixed assets decreased continuously from US$10.09 million in 2012 to US$8.51 million in 2016. This is mainly because divestiture of the IS&GS business and reclassification of the IS&GS business to discontinued operations for all periods (Lockheed Martin Corporation, 2016). In the same way, Northrop’s sales to fixed assets ratio also decreased. However, compared to 2016 on the chart, US$1.68 million was less than Lockheed. It means that Northrop’s efficiency in using net tangible assets was weaker than Lockheed.

Investment decision ratios

To attain an Investment decision ratio, net income for a specific fiscal year is divided by the total number of issued shares. Earnings per share represent the net income earned per share for the past one year. This is the central indicator of equity investment (Marquardt and Wiedman, 2005). Lockheed’s earning per share increased from US$8.36 in 2012 to US$17.49 in 2016. The increasing trend was due to Lockheed’s development and growing revenue and especially reached the peak at US$17.49 in 2016. This was as a result of the sales of US$47.2 billion, up 17% versus 2015 (Lockheed Martin Corporation, 2016). On the other hand, there was an issue in 2014 which Lockheed made contributions of US$2.0 billion related to their qualified defined benefit pension plans (Lockheed Martin Corporation, 2014). At the same time, Northrop’s earnings per share also kept growing on the same period and reached at US$12.19 in 2016, however, this number was US$5.3 less than Lockheed, mainly because of its less net income.
Price/Earnings Ratio
Price/Earnings Ratio is another useful indicator of investment decision. Lockheed’s price/earnings ratio increased from US$11.23 in 2012 to US$18.95 in 2015 .It later fell to US$14.29 in 2016 because they repurchased of common stock during 2016.

Figure 9. Trend analysis for Price/Earnings Ratio and Market Price per Common Share

Cash flow ratios
Total retained earnings and depreciation expense in the balance sheet are known as cash flow of the company. It is the most important (McLaney and Atrill, 2015). Thus, cash flow ratios are also important in estimating a company’s ability.

Sharp rises of cash flow from operations led to the increase of Lockheed’s cash flow/total debt ratio from 4.04% in 2012 to 11.23% in 2016. It reached the peak at 14.54% in 2013, however, this surge was partly an increase of the gain on outstanding balance of approximately US$200 million from US government which US government held Lockheed’s bill in 2012. Northrop’s cash flow/total debt ratio was 13.82% in 2016. This was higher than Lockheed’s debt ratio. That means that Northrop has better cash flows than Lockheed, even though Lockheed has the larger market share.

Part Two: Finance Cluster Analysis

Capital Structure
Capital structure is the composition of debt and equity on the balance sheet (Vernimmen et al., 2014). The figure of total equity, long-term debt and short-term debt of Lockheed and Northrop can be found from both of FinSas and Bloomberg. With the companies of total equity, long-term debt and short-term debt, the value of the firms and percentages of capital structure can be calculated by the following equations (Vernimmen et al., 2014):
Value of the firm= mkt. value of debt + mkt. value of equity
E/V= mkt. value of equity / value of the firm

D/V= mkt. value of debt / value of the firm
The calculation and result are as below:

The pie charts below can show the capital structure clearly:

Figure 10. Pie charts of Lockheed Martin Corporation’s capital structure from 2012 to 2016

Figure 11. Pie charts of Northrop Grumman Corporation’s capital structure from 2015 to 2016
The average of equity and debt for Lockheed during the last five years are 85.57% and 14.43%. Lockheed has debts from the last five years that may lead to some unstable earnings. Debts attract additional expense in interest and a higher risk. They also influence stock prices since most investors consider the risk before investing. However, it might save some costs of capital (Vernimmen et al., 2014).
Similarly, Northrop’s capital structure also consisted of both debt and equity in 2015 and 2016. However, the numbers were lower than Lockheed, which means that even if there are risks, there is a relatively favourable sign to prove its ability to cover liquidities than Lockheed can do. The cost of equity is often more expensive than the cost of debt, thus capital structure may result in relatively higher cost than a balance of debt and equity existing together.
Valuation estimate
Valuation for a company is normally related to its input and the value compared to similar stocks on relative ratios such as price/earnings, price/cash flow to determine. The process is calculated as follows:

Weighted average cost of capital (WACC)
WACC is a calculation of a firm’s cost of capital in which each category of capital is proportionately weighted’ (Investopedia, 2018). According to Vernimmen et al. (2014), below equations can be used to calculate WACC:

Relevant figures in the fiscal year 2016 for Lockheed can be found both of Bloomberg and FinSas in the below:

WACC in the fiscal year 2016 for Lockheed can be calculated via the below formats:

STEP 1: Capital Structure (Based on 2016)
E= Common Shares Outstanding
Market Price per Common Share= 289.00 * 249.94=72,232.66
V= D+E+P= 14,282+72,232.66+0=86,514.66
WE=E/V= 72,232.66/86,514.66=0.8349
WD=D/V= 14,282/86,514.66=0.1651

STEP 2: Cost of Equity (Based on 2016)
Ke=rf+B (rm-rf) = 2.44%+0.79x (8.97%-2.44%) = 2.44%+0.79×6.53%=7.60%

STEP 3: Cost of Debt (Based on 2016)
Kd= (Short term Debt/Total Debt x Long term Debt/Total Debt x RS) xFD= (0x1.19%+1×2.44%) x1.38= 3.37%

STEP 4: Weighted Average Cost of Capital (Based on 2016)
WACC=WdxKdx (1-Tc) +WexKe= 0.1651×3.37%x (1-23.19%) +0.8349×7.60%= 6.77%

Return on investment for Lockheed in the fiscal year 2016 is 12.52%, which is higher than its WACC in 2016, which mean its good profitability to cover its capital. According to Bloomberg, Northrop’s WACC was 7.1% in 2016. This was slightly higher than Lockheed. Northrop’s return on investment in 2016 was 12.14%. It is also higher than its WACC, showing its profitability as well.
Dividend Policy

During the last five years, Lockheed kept declaring regular cash on every quarter, which was all funded by surplus cash on the balance sheet in the related years. Lockheed’s corporate tax rate was 23.19% in 2016, which was lower than the personal tax rate of 25% income more than US$37,651 to US$91,150. Northrop kept declaring regular cash on every quarter, the amounts were slightly less than Lockheed.
On the whole, Lockheed Martin Corporation is world largest market share in the aero crafts and weapon industry, therefore, it has the ability to make profits. It is also very attractive to investors because of a huge amount of cash flow income, growing investment decision ratios.

FinSAS for Lookheed
1.1. Input

1.2 Ratios

2. FinSAS for Northrop Grumman Corporation

2.2 Ratios

Atrill, P. and McLaney, E. (2015) Accounting and finance for non-specialists (Ninth Edition). London: Pearson.
Deloitte (2016) “2016 Global aerospace and defense sector outlook”
Gibson, C. H. (2012) Financial Reporting and Analysis: Using Financial Accounting Information (13th Edition), Belmont: South-Western Cengage Learning
LOCKHEED MARTIN CORPORATION (2016) Lookheed Annual Report FY2016.
LOCKHEED MARTIN CORPORATION (2015) Lookheed Annual Report FY2015.
LOCKHEED MARTIN CORPORATION (2014) Lookheed Annual Report FY2014.
LOCKHEED MARTIN CORPORATION (2013) Lookheed Annual Report FY2013.
LOCKHEED MARTIN CORPORATION (2012) Lookheed Annual Report FY2012.
Northrop Grumman (2016) Lookheed Annual Report FY2016.
Northrop Grumman (2015) Lookheed Annual Report FY2015.