The F-35 is a Keeper; So is Lockheed Stock

After a market-beating run that lasted several years, shares of the nation’s leading defense contractors have underperformed the broad market over the past twelve months. The reason? Investor fears that soaring federal budget pressures will cause Pentagon spending to slow in coming years.

LMT, NOC, GD, RTN, SPY Chart by YCharts

There’s a certain logic to that view, even though weapons programs have historically proven harder to kill than cockroaches (Congress loves the jobs they provide). Still, a cost-conscious Uncle Sam may in the future dial back the scope of certain weapons programs, or eliminate some outright.

In the case of Lockheed-Martin (LMT), however, those fears have been overdone. The world’s biggest defense contractor supplies a variety of warplanes, ships and electronic gear to the government, but the key to its future is the F-35 Joint Strike Fighter – the biggest weapons program in history.

Though Lockheed’s only produced a relative handful of test aircraft so far, it’s expected to eventually deliver over 3,000 F-35s to our military and several allies, for a total of over $300 billion … and to garner more than twice that sum from maintenance and spare-parts contacts.

Thanks to design changes, testing problems, and supply-chain issues, the fighter program is now years behind schedule, (delivery to start in 2016) and its cost has risen by more than 50 percent from original estimates. Pentagon officials have been showing signs of sticker shock.

Does all this make Lockheed’s expensive baby vulnerable to deep future cuts? The answer is almost certainly ‘no,’ thanks to a Pentagon cost-saving plan that effectively made the F-35 the only viable new jet design.

The F-35 contract Lockheed beat out Boeing (BA) for almost a decade ago is so huge because the government opted to make just one basic aircraft design serve all branches. Putting all the Pentagon’s combat-aircraft eggs in one basket was aimed at reducing development, maintenance and overhead costs. But it also boxed in Uncle Sam: cancelling the “stealth” jet program and starting over now would delay the military’s access to a next-generation fighter by more than a decade.

All of which suggests that the F-35 program is as close to untouchable as a weapons program can get. Lockheed’s share price doesn’t reflect this fact.

YCharts Pro, which rates Lockheed shares“attractive,” sure thinks so. Of course, YCharts can’t know how the Pentagon will be tossing its money around in future years. It just likes Lockheed’s stable cash flow, solid dividend yield, and the $4 billion it spent on share buybacks last year.

LMT Stock Chart by YCharts

While Lockheed’s margins have held up quite well, the stock’s decline has depressed its multiple to historically low levels.

LMT Stock Chart by YCharts

Some investors have grown wary of the big defense players because the wars in Iraq and Afghanistan are due to wind down. But that doesn’t hold up: Because they specialize in big-ticket “platforms” produced under decades-long contracts, Lockheed and its major rivals aren’t much affected by conflicts like the Iraq or Afghanistan actions.

They profit instead when a weapon design is a major winner, like Lockheed’s hugely successful F-16, which yielded a long production run and lucrative sales to foreign buyers. (Or take a hit if a contract doesn’t work out, as when the Navy first told Raytheon (RTN) it wanted 32 “Zumwalt-class” destroyers at $3 billion a pop, but later cut the order to only three.)

Lockheed’s huge defense contract is crucial enough to escape that kind of budget axe. And Lockheed shares deserve more respect.