How Much Do Government Contracts Contribute to Defense Suppliers’ Revenue Share?
Table of Contents
- Lockheed Martin (NYSE: LMT)
- Boeing (NYSE: BA)
- Raytheon (NYSE: RTX)
- Booz Allen Hamilton (NYSE: BAH)
- Defense Sector Peer Analysis
Keeping track of government contract awards is essential to assessing the financial health of companies operating in the defense sector. As the world is eerily watching whether a recession is around the corner, government contracts will prove to be a lifeline to companies should their commercial business take a hit.
Figure 1. Contract awards by the U.S. Department of Defense, 2018-Q3 2022
The article looks at the four largest defense suppliers in the US - Lockheed Martin, Boeing, Raytheon Technologies, and Booz Allen Hamilton in respect to their latest quarterly and annual results, and the significance of government procurement for their revenue.
Lockheed Martin (NYSE: LMT)
Lockheed Martin 2022 Q2 Results Overview
Lockheed Martin reports results in four key segments, namely Aeronautics at 38% of Q2 2022 net sales, Missiles and Fire Control at 18% of Q2 2022 net sales, Rotary and Mission Systems at 26% of Q2 2022 net sales and Space at 18% of Q2 2022 net sales.
Figure 2. Lockheed Martin 2022 Q2 Net Sales Breakdown
Source: Lockheed Martin Form 10-Q for Q2 2022
Lockheed reported a 9.3% drop in sales year-over-year, citing supply chain issues and the timing of a key F-35 contract as the main culprits behind the sales decrease. On the other hand, operating margins were better, improving to 11% from 10.4% in the prior year quarter. Overall, operating profit decreased by 3.7% Y/Y.
The company’s backlog was marginally up to $134.6bn (Q1 $134.2bn), with 59% expected to be realized over the next 24 months.
Turning to the outlook, LMT cut its 2022 sales guidance by 1% to $65.25bn with the free cash flow guidance at over $6bn remaining intact thanks to stronger operating profit margins.
If free cash flow grows by 10% per year over the next three years, it may reach $8bn. In that scenario, the 2025 free cash flow yield against the current market cap of $106bn would be over 7% which, coupled with a 3% general economy growth rate (which is also what the military spending growth rate is widely seen as), should take the post-2025 expected return to around 10%.
Due to the fact that Lockheed Martin has no tangible stockholders’ equity after you take liabilities into account, the company’s current valuation is based entirely on its earnings generation capacity. Therefore, forward-looking government receivables data could prove to be a strong indicator of Lockheed Martin’s future performance.
Lockheed Martin Government Revenue Share
When it comes to government-dependent companies, few match the definition as closely as Lockheed Martin. As per the company’s 2021 annual report:
In 2021, 71% of our $67bn in net sales were from the US Government, either as a prime contractor or as a subcontractor (including 62% from the Department of Defense (DoD)), 28% were from international customers (including foreign military sales (FMS) contracted through the US Government) and 1% were from US commercial and other customers.
Boeing (NYSE: BA)
Boeing 2022 Q2 Results Overview
Boeing reports results in three main divisions, namely “Commercial Airplanes” (BCA) at 37.2% of Q2 2022 revenues, “Defense, Space & Security” (BDS) at 37.1% of Q2 2022 revenues and “Global Services” (BGS) at 25.8% of Q2 2022 revenues:
Figure 3. Boeing Revenue Breakdown
Source: Boeing Form 10-Q for Q2 2022
The Defense, Space & Security segment recorded the weakest revenue performance in the quarter, with a 10% Y/Y drop. Boeing recorded a number of one-off charges in Q2, including a $147m in the MQ-25 program and a $93m charge in the Commercial Crew program.
Backlog at Defense, Space & Security was $55 billion, of which 33% percent represents orders from customers outside the US.
Growth in the Global Services segment was driven by higher commercial services volume, partially offset by lower government services volume. Boeing expects the recovery in the segment to continue in the coming years as the industry returns to pre-pandemic levels, albeit at a slower pace than observed until recently.
The big news for Boeing came after the Q2 results with the resumption of 787 Dreamliner deliveries. The company still anticipates 787 abnormal costs of approximately $2bn, with most being incurred by the end of 2023, including $283m recorded in the quarter.
Boeing aspires to be cash flow positive in 2022, in order to maintain its commitment to reduce its debt levels. In Q2 2019, the company’s debt was circa $19bn. In Q2 2022, it has ballooned to about $57.2bn, which, coupled with the ongoing one-off costs related to the 787 Dreamliner, make it hard to believe that its stock will achieve positive momentum in the near future.
Boeing Government Revenue Share
Boeing’s Defense, Space & Security segment has the US Department of Defense as its primary customer. Revenues from the US DoD, including foreign military sales through the US government, accounted for approximately 84% of its 2021 revenues. (Boeing 2021 annual report).
Government spending is also important for the Global Services segment, with 40% of 2021 revenue coming from the US government. Overall, 49% of Boeing’s 2021 revenues were earned pursuant to US government contracts.
Raytheon (NYSE: RTX)
Raytheon 2022 Q2 Results Overview
Raytheon reports results in four main segments, namely Collins Aerospace Systems at 29.2% of Q2 2022 net sales, Pratt & Whitney at 29% of Q2 2022 net sales, Raytheon Intelligence & Space (RIS) at 20.9% of Q2 2022 net sales and Raytheon Missiles & Defense (RMD) at 20.8% of Q2 2022 net sales:
Figure 4. Raytheon 2022 Q2 Sales Breakdown
Source: Raytheon Technologies Form 10-Q for Q2 2022
Collins Aerospace Systems saw sales growth of 10.2% Y/Y on the back of recovering commercial air traffic, partially offset by weakness in military sales.
Pratt & Whitney reported the highest revenue growth in the quarter at 16% Y/Y fueled by both commercial and government orders.
In contrast to buoyant market conditions enjoyed by the former two segments, results at RIS & RMD were lackluster with sales coming in at -6% for RIS and -11% for RMD respectively. Backlog at both divisions was relatively flat, up $1bn to $30bn at RMD but down $2bn to $16bn at RIS.
All in all, Raytheon confirmed its full-year 2022 forecast, with free cash flow seen at circa $6bn, up from $5bn in 2021:
Figure 5. Raytheon 2022 Forecast
Source: Raytheon Technologies Q2 2022 Investor Webcast Presentation
It can be expected that growth will moderate going into 2023 on the back of a more gradual recovery in air traffic, offset by a pick-up in government defense spending.
Raytheon Government Revenue Share
As per Raytheon’s 2021 annual report, US government sales made up 48% of total 2021 sales.
Adding the 9% in foreign military sales through the US government and the 8% in direct foreign government commercial sales, total government exposure in 2021 was 65%.
Figure 6. Raytheon Sales Breakdown 2019-2021
Source: Raytheon Technologies Form 10-K for 2021
Booz Allen Hamilton (NYSE: BAH)
Booz Allen Hamilton 2023 Q1 Results Overview
Bearing in mind that Booz Allen Hamilton’s financial year starts in April, the company reports revenues in three main customer segments, namely Defense Clients at 45% of Q1 2022 revenue, Intelligence Clients at 18% of Q1 2022 revenue and Civil Clients at 34% of Q1 2022 revenue.
Figure 7. Booz Allen Hamilton Revenue Breakdown 2021-2022
Source: Booz Allen Hamilton Form 10-Q for Q1 2023
Of the 13.1% revenue growth in the quarter, 8% was organic with the rest made up by inorganic contributions. Booz Allen Hamilton remains committed to being active on the M&A front to help it reach its adjusted EBITDA target of $1.2bn to $1.3bn in fiscal 2025.
Turning to the backlog, it saw growth of 6.8% Y/Y to $28.6bn.
Expectations for fiscal year 2023 have it that revenue growth will be between 5% and 9%, inclusive of inorganic contributions, while operating cash flow will be between $850m and $950m.
Booz Allen Hamilton Government Revenue Share
Booz Allen Hamilton relied on US government contracts for 97% of its fiscal 2022 revenue, comparable to Lockheed Martin’s 99% government contract exposure.
Defense Sector Peer Analysis
After lackluster growth in the previous decade, the defense sector is poised for a comeback in the years to come. Against the backdrop of a looming recession and rising interest rates needed to temper down inflation, some players such as Lockheed Martin and Booz Allen Hamilton are in a better position to weather economic headwinds. The high proportion of government spending as a percentage of their revenues secures their position as it ensures predictability of their cash flows. Of the four companies, Boeing remains a turnaround play and is most exposed to commercial developments in the aviation sector. Raytheon will also benefit should the air traffic recovery continue, and is also shielded to an economic downturn with its sound financial health and 65% government spending exposure.
Figure 8: Defense Suppliers Government Sales Share out of Total Sales (2021)
|US Government Sales %, 2021||Total government sales %, 2021||Earnings Yield||Market cap to net debt|
|Booz Allen Hamilton||97||N/A||4.4%||5.6|
Source: Company 10-K Filings for 2021
*Note that Boeing and Booz Allen Hamilton do not break down total government sales
As shown on Figure 8, all four companies rely heavily on government sales. For Booz Allen Hamilton, US government sales make up as much as 97% of the company’s sales. For defense heavyweight Lockheed Martin 2021 revenues from government sales amounted to 99%, with 71% coming from sales to the US government alone.
Just below the 50% mark, Boeing and Raytheon have also generated much of their sales in 2021 from entering contracts with the US government (49% for Boeing and 48% for Raytheon).
In conclusion, we once again posit that monitoring the public procurement activity of major players within the defense sector is worthwhile due to their well-documented dependence on government contracting. This holds particularly true in light of the relationship between government receivables and stock movement that we have discovered and discussed in one of our white papers.