Better Buy: GE Aerospace vs. Lockheed Martin

Comparing the commercial aerospace giant GE Aerospace (GE) with the prime defense contractor Lockheed Martin (LMT 0.56%) it is always interesting because it requires a big picture. It’s not about a quarter’s earnings or even a year’s worth; it refers to a long-term view of how each company makes money. So let’s dive in and see what we can find out.

The more stock the better

Spoiler alert: GE Aerospace, which makes aircraft engines, is the better stock. While not everyone will agree with this conclusion, the debate will shed some light on the long-term investment cases for each stock.

GE Aerospace operates in the commercial aviation industry, an indispensable part of the global economy. While airlines have not always been such great investments, and the industry has experienced periodic ups and downs, airlines have not traditionally had a problem raising debt (not least because the debt is securitized with assets valuable, the planes themselves).

Furthermore, there is no way to avoid air travel if you want to travel long distances quickly.

GE Aerospace’s market position

As such, GE Aerospace operates in an industry with only two truly global aircraft manufacturers, Boeing and Airbus. This means it has a high level of certainty about its development programs. At the same time, there are numerous end-market customers, including the airlines themselves. As mentioned above, even if some airlines fail, usually others backed by bondholders follow.

With engines on both large narrow-body aircraft — the Boeing 737 MAX and the Airbus A320 neo family (RTX also provides an engine on these aircraft) — GE Aerospace is ideally positioned to generate profitable aftermarket revenues from its engine installed base for many decades to come.

Aircraft engines can last over 40 years and generate parts and service revenue over that cycle as they are overhauled and repaired. This is in addition to a highly favorable set of end-market conditions, where GE Aerospace has a high degree of certainty about the development of its engines (sold mainly in the Boeing and Airbus programs) and a high degree of certainty about the market its bottom lines due to the ability to diversify and reduce risk by selling engines to many different airlines.

Lockheed Martin: This time, it’s not the same

For investors who don’t believe in coincidences, there’s a lot to consider when it comes to the big defense contractors. Boeing’s defense business continues to generate losses, particularly on fixed-price development programs. RTX’s defense business, meanwhile, continues to struggle with profit margins and recently took a charge for ending a fixed-price development program in its defense business. RTX also lowered its overall free cash flow guidance in 2024 because of the issue.

The bull case for Lockheed Martin

Back to Lockheed Martin, the defense contractor has also had margin problems in recent years. Management believes 2024 will be a low for margins, and according to CFO Jesus Malave on the latest earnings call, the company expects margins to “gradually improve over the next few years.”

Defense companies’ recent margin struggles are challenging the investment narrative around defense stocks. Investors like defense stocks because they are seen as being in a relatively stable industry with solid growth prospects and low market risk because their clients are sovereign governments.

Image source: Getty Images.

Defense bulls will argue that recent margin pressures are focused on fixed-price development programs purchased in less inflationary times. In addition, defense companies have been uniquely affected by supply chain issues, rising raw material prices, and product availability issues (eg, rocket engines or titanium castings).

The bulls argue that margins will improve once these problems ameliorate and Lockheed Martin and others work through fixed-price programs.

The bear case for Lockheed Martin

The other side of the argument notes that margin deterioration appeared to be in place before anyone had heard of the pandemic. Moreover, many other industrial companies have overcome supply chain difficulties and raw material prices, but the defense industry is having a much harder time — suggesting this may be a structural rather than temporary problem.

LMT Gross Margin Data by YCharts

Moreover, with seemingly ever-increasing levels of sovereign government debt, there is a tangible move toward forcing fixed-price programs on defense contractors. This is a real concern as it suggests that the industry needs to prepare for structurally lower margins in the long term.

GE Aerospace vs. Lockheed Martin

All in all, investors have cause for concern until the issue of structural profit margins is resolved in the defense industry. Despite the cyclical risk in the commercial aerospace industry, GE Aerospace is the best buy because its long-term earnings growth trajectory looks safer.