Why Lockheed Martin and General Dynamics just declared war on rocket engines

What do Iranian drones have in common with Russian hypersonic missiles and China’s DF-21D “carrier killer” missile? All three pose a clear and present danger to US forces and their allies, and all three require air defense missiles to protect against this threat.

This is a problem for the US and allied militaries, but also for defense companies such as Lockheed Martin (LMT -0.36%) and RTX Corporationmakers of the famous PATRIOT air defense missile (as well as many other missiles, such as the equally famous HIMARS missile used in Ukraine today).

Defense products, you see, involve long supply chains — similar to what’s seen in the auto industry — where a company can produce a final product (like a PATRIOT) but depends on subcontractors to produce the components that goes into that final product. . You probably remember how the lack of semiconductor chips for low-tech cars led to a widespread shortage of cars during the pandemic, for example. Well, today, the slow lack of rocket engines is a bottleneck for missile production by America’s defense companies as well.

From problem to solution

The Wall Street Journal reports that Northrop Grumman and L3Harris are the two defense giants that dominate the production of rocket engines. Both have drawn flak from Lockheed and RTX for their failure to produce enough to meet demand. To remedy this situation, Lockheed Martin proposed to enter the business of making rocket engines.

It’s a big job, though, and Lockheed can’t do it alone. Last week, the company confirmed it would form a joint venture with the defense rival General dynamics (G.D -0.68%)which aims to develop a new generation of military rocket engines to complement the limited supply produced by Northrop and L3Harris.

In this partnership, Lockheed will apparently act largely as a silent partner (and exclusive customer), although it is assisting with engine design and testing. General Dynamics will do the actual production at its munitions plant in Camden, Arkansas, then ship them next door to the Lockheed Martin Multiple Launch Guided Missile (GMLRS) assembly plant. The GMLRS is one of the primary weapons launched by the HIMARS missile launchers. With General Dynamics meeting all of Lockheed’s engine needs for this type of missile, it should decrease the demand for engines for other missiles, helping to unblock the supply chain for both Lockheed and everyone else.

What it means for Northrop and L3Harris

In the long term, the joint venture could expand production to supply engines for other types of rockets produced by Lockheed and other buyers, also creating a permanent rival for Northrop and L3Harris in the rocket engine market.

L3Harris’ Aerojet Rocketdyne subsidiary provides just 5.4 percent of the company’s total annual revenue, according to data from S&P Global Market Intelligence, limiting its exposure to this new threat. The effect on Northrop Grumman is harder to gauge. Rocket engines are part of the company’s space systems division (which is quite large, accounting for 35% of Northrop’s annual revenue).

It’s hard to say, however, how much of that revenue comes specifically from rocket engines.

What it means for Lockheed Martin and General Dynamics

What seems clear is that the new joint venture has the potential to benefit Lockheed Martin and General Dynamics quite a bit. Northrop Grumman earns a respectable 8.7% operating margin on its “space” business, while L3Harris’ Aerojet unit generates even better margins of 11.6%.

Those aren’t bad numbers at all, assuming a Lockheed-GD joint venture can duplicate them. Moreover, while expanding rocket motor production helps Lockheed sell more complete missiles to its customers, operating margins at Lockheed’s missile and fire control division are about average. 12.9%! Increasing sales in that unit would clearly be a big boost to his business.

As for General Dynamics, the fourth part of this four-way dynamic could benefit the most. GD’s combat systems division would do the heavy lifting in building these new rocket motors (I should also point out that Lockheed wants to increase GMLRS production by 40% this year). GD already earns operating profit margins of 13.9% on its combat systems sales, easily making it the company’s most profitable business.

Simply put, if this deal comes together, General Dynamics stock will be the biggest beneficiary of all.