Lockheed's F-35 deal ratchets up pressure to slash production costs

Lockheed Martin's new deal with the Pentagon for F-35 fighters lowered the purchase price by nearly 8 percent yet should still be profitable for the defense contractor, according to industry analysts.

That said, experts say Friday's agreement — valued at $8.7 billion, by some analysts — will step up the pressure on the defense giant to continue cutting the F-35 Joint Strike Fighter's production costs and it risks margin erosion too.

"I'd say it's pretty aggressive price reductions," said Morningstar analyst Chris Higgins. "The key is Lockheed needs to reduce the costs at a faster rate than they are cutting the price."

Lockheed has been under pressure from President Donald Trump to reduce the costs of the F-35 — the Pentagon's largest weapons program ever. Trump also suggested that the government might want to buy some of Boeing's F-18 fourth-generation fighters as an alternative to the fifth-generation F-35 aircraft.

"We're pleased to have reached an agreement with the U.S. Department of Defense for the next 90 F-35 aircraft," Lockheed said in a statement. "The agreement represents $728 million in savings and a nearly 8 percent reduction in price over our last contract for the air vehicle delivered by Lockheed Martin and our industry partners."

Added Lockheed, "The increase in the number of aircraft in this agreement enables us to reduce costs by taking advantage of economies of scale and production efficiencies."

F-35 cost breakdown

F-35 Cost Breakdown	Breakdown of Costs	Change from Lot 9
F-35A (Air Force model)	$94.6 million	-7.3%
F-35B (Marine Corps)	$122.8 million	-6.7%
F-35C (Navy)	$121.8 million	-7.9%

Source: Lockheed

Lockheed maintained that "the agreement was reached in a matter of weeks and represents significant savings over previous contracts."

Most of the planes being ordered by the Pentagon are for the F-35A, a conventional takeoff and landing variant for the U.S. Air Force. There's also the F-35B variant for the Marines Corps capable of short takeoffs and vertical landings, while the F-35C for the Navy is a carrier variant.

Lockheed's agreement announced Friday involves a contract for the tenth batch of F-35 aircraft and a total of 90 jets — a more than 40 percent increase from the previous lot. That includes 55 jets for the U.S. armed services and 35 jets for international partners and foreign military sales customers, Lockheed said.

The lot 10 deal cut the per-plane price on the F-35A to $94.6 million, or a 7.3 percent price reduction from the previous lot 9 terms. That marks the first time the F-35A variant has been below $100 million and also represents a more than 60 percent price drop on the plane since the first production lot.

Meantime, the lot 10 terms have the F-35B variant's per-plane price at $122.8 million, down 6.7 percent from the lot 9 terms. And the F-35C variant's per-plane price is $121.8 million, or 7.9 percent below the lot 9 price.

Higgins said that the price reductions on lot 10 were "on the high end of what they were talking about. They were talking about 6 to 7 percent price reductions compared with lot 9 and you're looking at the price reductions above 7 percent (on the F-35A and F-35C)."

Lockheed has been bringing down the recurring costs on the aircraft, he said, and the F-35 program still is profitable for the company and likely will remain so. Still, the analyst expects there's a question about whether the defense contractor will be able to expand margins as quickly on the F-35.

"They were expecting margin expansion on it," said Higgins. "This could potentially put that in jeopardy."

U.S. Navy | Reuters

F-35 Bravo Lightning II stand ready on the deck of amphibious assault ship USS Wasp for day two of the first phase operational testing in the Atlantic Ocean in this handout photo taken May 19, 2015 and provided by the U.S. Navy.

Nevertheless, Cowen analyst Cai von Rumohr counters that lot 10 "appears to be in line with expectations." In a research note, he said the deal also "supports firming F-35 prospects" and suggests Lockheed's Aeronautics division could see "upside in 2018-19."

The Cowen analyst sees F-35 sales up 14 percent per year to $17.4 billion by 2019, based on the lot 10 deliveries and sustainment ramp. Lockheed records revenue on the planes as they build the aircraft; the company is still building lot 9 planes.

To date, more than 200 F-35 planes have been delivered. Besides the U.S. military, the planes are operated by seven other nations, including Australia, Italy, Israel, Japan, Netherlands, Norway and the U.K. More than 3,000 F-35 aircraft are expected to be manufactured, with about 600 of those planned to be procured by international allies.

In trading Friday, Lockheed stock rose nearly 1 percent.