Defense and Aerospace Investor Overview: Lockheed Martin, Raytheon, Cost-Plus Contracts

Defense stocks outperform during geopolitical crises because crises create direct and indirect demand catalysts for defense spending that benefit defense contractors through multiple channels. The most direct channel is munitions replenishment: when the U.S. transfers missiles, artillery shells, and air defense systems to an ally (as happened extensively with Ukraine after the 2022 Russian invasion), the Department of Defense must replenish those stockpiles, placing production orders with companies like RTX (Patriot missiles), Lockheed Martin (HIMARS rockets, Javelin missiles), and Northrop Grumman (air-to-air missiles). These replenishment orders represent incremental revenue above the normal procurement baseline. The indirect channel is allied defense spending: a geopolitical crisis typically accelerates defense budget growth among NATO and Indo-Pacific allies who increase their own military spending in response to perceived threats. European NATO members were spending an average of 1.6% of GDP on defense before the Ukraine war; by 2024, most had committed to the 2% NATO guideline, with Germany, Poland, and others going significantly higher. This European defense spending increase benefits U.S. prime contractors through foreign military sales of F-35 fighters, Patriot missile systems, Abrams tanks, and other U.S.-standard platforms. A third channel is domestic U.S. supplemental spending: Congress typically passes emergency supplemental appropriations to replenish equipment, fund aid to allies, and increase production capacity following crises, directly funding orders to defense contractors outside the normal budget cycle. Investors anticipate these demand catalysts, and defense stocks typically appreciate before the actual orders are placed, pricing in the expected revenue benefit. The timing advantage of defense stocks in geopolitical crises is not guaranteed -- markets can overestimate demand, programs can be canceled, or the crisis can be resolved quickly -- but the mechanism connecting geopolitical tension to defense contractor revenue is direct and historically reliable.

The F-35 Lightning II Joint Strike Fighter is a fifth-generation, multi-role stealth fighter aircraft developed by Lockheed Martin as the primary U.S. tactical aircraft of the 21st century, intended to replace the F-16, F/A-18, AV-8B Harrier, and A-10 Thunderbolt II across the Air Force, Navy, and Marine Corps. Three variants serve the three services: the F-35A (conventional takeoff, Air Force), F-35B (short takeoff and vertical landing, Marine Corps), and F-35C (carrier-based, Navy). The program started in 2001 after Lockheed won the Joint Strike Fighter competition, and it is the largest defense acquisition program in history by total estimated lifetime cost ($1.7+ trillion for development, procurement, and sustainment through 2070). The F-35 is financially critical to Lockheed Martin for three reasons: scale, longevity, and sustainment. Scale: the program accounts for 25-30% of Lockheed's annual revenue, representing approximately $15-18 billion annually in combined production and sustainment revenue. Longevity: the program will run for 50+ years from first delivery (2015) to planned end-of-life (2070+), providing exceptional revenue visibility for shareholders and bondholders planning over multiple business cycles. Sustainment: once the production phase winds down (planned at roughly 3,000 aircraft by the late 2030s), the program enters a sustainment phase where Lockheed maintains the global fleet of F-35s under long-term performance-based logistics (PBL) contracts. A fleet of 3,000 aircraft, each requiring $3-5 million annually in maintenance, parts, upgrades, and support, represents a $9-15 billion annual sustainment annuity extending through 2070. Lockheed's F-35 sustainment revenue is arguably the most durable, long-lived revenue stream in any public company -- the government cannot easily substitute another supplier for an aircraft it has committed to operating for 50+ years, and the integrated nature of the maintenance infrastructure makes the switching cost effectively prohibitive.

When Congress fails to pass defense appropriations on time -- which has occurred in most years since 2010, either as a continuing resolution (CR) or government shutdown -- defense contractors face a specific set of operational constraints that compress near-term revenue and create program execution challenges. A continuing resolution funds the government at the prior fiscal year's appropriated level, typically as a percentage of that level (e.g., 99% of prior-year funding). CRs explicitly prohibit starting new programs, entering new production contracts at different quantities than the prior year, or beginning new activities not already in the prior-year baseline. For defense contractors, these restrictions create several practical problems. First, new contracts for items that did not exist in the prior fiscal year (new weapons systems, new production lots at higher rates, new R&D programs) cannot be awarded until regular appropriations are enacted. This delays contract awards, pushing revenue recognition into future quarters and forcing contractors to fund continuing work from their own balance sheets without contractual authority. Second, CR-funded programs at prior-year rates cannot ramp up production even when there is clearly appropriated demand for higher quantities in the current year's proposed budget; this creates staffing and supply chain inefficiencies as factories operate below planned capacity. Third, government program offices operating under CRs often freeze discretionary spending (travel, studies, incremental data purchases) to preserve available funds for critical payments, affecting contractor programs that depend on government decision-making during the CR period. A shutdown (full cessation of non-essential government funding) is more severe: all non-essential government employees are furloughed, including most program managers and contracting officers who award and administer defense contracts. During shutdowns, existing contracts continue to be executed because defense is considered essential, but no new contracts can be awarded, options exercised, or contract modifications issued until the shutdown ends. Multiple weeks of government shutdown in a fiscal year can push $2-5 billion of expected orders into subsequent quarters, compressing reported revenue and requiring subsequent catch-up that creates lumpy revenue recognition.

Backlog is the total value of contractual orders that defense contractors have received from customers but not yet performed work on and recognized as revenue -- essentially the cumulative value of all signed contracts with work still to be done. Defense contractor backlog has two components: funded backlog (contractual orders where the government has appropriated money and obligated it to the specific contract, meaning the cash commitment is locked in) and unfunded backlog (contractual orders with ceiling values established but not yet funded by appropriation, often representing multi-year contracts where future-year funding must still be appropriated by Congress). Funded backlog is a high-quality, reliable revenue indicator: the government has appropriated and obligated the funds, and the contractor is virtually certain to recognize that revenue as it completes the work. Unfunded backlog is softer: it represents the government's intention to continue funding the program, but annual appropriations can reduce or terminate programs before the full ceiling is funded. For defense investors, backlog is the most important metric because it provides direct visibility into future revenue, which is unusually difficult to obtain in most industries. A company with $150 billion of backlog (as Lockheed Martin consistently carries) has 5+ years of revenue coverage at current rates, meaning revenue growth is largely determined by the rate of backlog burn (how fast work is completed and revenue recognized) and the rate of new orders (how fast new contracts replenish the backlog). The book-to-bill ratio -- new orders in the period divided by revenue recognized in the period -- is the leading indicator: a book-to-bill above 1.0x means backlog is growing and future revenue is expanding; below 1.0x means backlog is declining and future revenue growth will be limited. Backlog quality (funded vs. unfunded, development program vs. production, domestic vs. FMS) also matters: a backlog composed of mature production programs with high funded percentages is more reliable than one heavily weighted toward development contracts or unfunded ceiling.

Defense companies are notable among large industrials for consistently returning capital to shareholders at high rates, and the mechanics of their capital return programs are shaped by the specific economics of the defense business model. The core dynamic is that defense prime contractors operate asset-light businesses relative to their revenue: Lockheed Martin generates $67+ billion in annual revenue from operations that require relatively modest capital investment (manufacturing facilities, R&D tools, test equipment) because the most capital-intensive assets in defense -- the test facilities, launch ranges, nuclear infrastructure, naval shipyards -- are largely government-owned. This asset-light model generates high free cash flow conversion: Lockheed typically converts 95-105% of net income to free cash flow, meaning depreciation roughly equals maintenance capex and the company has minimal organic growth investment need. With limited reinvestment requirements and limited acquisition opportunities (the DOJ has blocked several large defense mergers on competition grounds, including Lockheed's attempted acquisition of Aerojet Rocketdyne), defense companies channel the majority of free cash flow to shareholders through buybacks and dividends. Lockheed Martin has repurchased approximately $25-35 billion of its own shares over the past decade (roughly 30%+ of current market capitalization) and has grown its dividend at 7-10% annually. This buyback-heavy capital return model produces meaningful EPS growth even during periods of modest revenue growth because the share count declines significantly: if Lockheed earns $7 billion in net income but has bought back enough shares to reduce the count from 300 million to 270 million shares, EPS grew 11% without any revenue growth. Defense stocks are therefore sometimes categorized with bond-like characteristics (stable, regulated revenue, reliable cash flows) combined with equity-like optionality on geopolitical spending increases, making them attractive in both value and income investment portfolios, though their valuations (typically 18-25x earnings) reflect this quality recognition.