The economic imbalance of using a $4 million interceptor to strike down a low-cost missile or drone has become a strategic challenge for America and its allies. Conflicts over the past decade have demonstrated that the cost-per-kill math can no longer be ignored.

While attacking has become cheap, the cost of defending remains high. According to a Reuters report, the U.S. Navy has spent over $1 billion since late 2023 on defending ships in the Red Sea from Houthi-led missile attacks and drones.

A similar pattern has been observed in Iran’s recent strikes on the GCC, which have forced several Gulf states to turn to Ukraine for cheaper interceptors as an alternative to expensive U.S.-made missiles.

The changing dynamics have pressured legacy defense contractors, who have been urged by the U.S. military to develop cheaper air defense interceptors. On the other hand, new startups like Anduril and Epirus have stepped up by producing affordable counter-drone technologies at scale.

Lockheed’s Answer: PAC-3 ACE

Given the circumstances, an important development occurred on Monday during Britain’s Farnborough Airshow, where Lockheed Martin Corporation (NYSE:LMT) announced a lower-cost Patriot interceptor. The company, in a press release, said the new PAC-3 ACE would cost less than half the price of its PAC-3 MSE interceptors, which cost approximately $4 million per unit.

The defense contractor will collaborate with industry partners and suppliers in the United States and Europe on the initiative, which is expected to strengthen the resilience of America’s defense industrial base globally.

The introduction of PAC-3 ACE is aimed at filling the gap between cheap drone interceptors and the Patriot system’s main interceptor, the PAC-3 MSE, which is equipped with ​hit-to-kill technology and destroys incoming threats through direct impact instead of an explosive warhead.

The Bull Case

The PAC-3 ACE is expected to reaffirm the Patriot system’s dominance through reduced cost-per-kill, even as new low-cost entrants gain traction. Moreover, it will use existing PAC-3 software and IBCS integration, which should shorten development time and reduce R&D risks.

The budget-friendly interceptor is likely to expand the company’s total addressable market and secure broader adoption and sustainable long-term orders from allied nations that may not have been able to acquire the premium PAC-3 MSE interceptors.

The high-volume demand for the new interceptor could drive revenue growth through a broadened customer base and provide the grounds for further backlog expansion.

The announcement from Lockheed Martin Corporation (NYSE:LMT) at Farnborough also comes at a time of a rearmament boom in Europe as the war between Ukraine and Russia rages on, which could result in new sales channels and stockpile deals.

Tim Cahill, President of Lockheed Martin Missiles and Fire Control, told reporters that the company plans to build the weapons with American and European industry partners, while adding that the plan is to have ‘an entire European-sourced missile’ that is manufactured within the continent.

Cahill said that he was already in talks with several European countries over the matter. If successful, the development would further strengthen the defense contractor’s foothold in Europe and aid in tackling the market share risk it faces from local defense companies.

The Bear Case

Initial production could begin in 36 months, the company said. However, the aerospace and defense industry often faces schedule slippages.

Skeptics may also argue that the company has only claimed so far that the price will be less than half of the PAC-3 MSE and has not disclosed the actual price. Moreover, ‘less than half’ is still substantially higher than what other low-cost competing systems promise.

At the same time, while the development appears positive from a growth and revenue perspective, margin pressure due to lower pricing could impact EPS in the near-term until the company is able to scale production and sees a high volume of orders.

The Backlog, the Budgets, and the Bigger Picture

The new missile is just one of the growth catalysts for Lockheed Martin Corporation (NYSE:LMT). The defense prime is well-placed to address the cost-per-kill problem without compromising its systems-integration moat.

During the second quarter earnings call on July 23, the company said it had received new orders worth $65 billion during the quarter, taking its backlog to a record $230 billion, reflecting robust revenue visibility over the coming years, and shielding the defense contractor’s growth from any product’s success or failure.

Moreover, global rearmament demand remains strong. Sales grew 11% year-over-year during the recent quarter to $20.1 billion. Net earnings came in at $7.94 per share, beating analysts’ forecasts of $7.20 per share, and well above the prior year’s earnings of $1.46 per share. However, it must be noted that EPS last year was impacted by program losses and other charges.

Following the results, the company lifted its financial outlook for 2026 for both sales and profit, as Pentagon looks to replenish its arsenal as ongoing global conflicts intensify. Full-year revenue is now forecast in the range of $79.75 billion to $81.75 billion, up from the earlier estimates of $77.5 billion to $80 billion. This is above analysts’ average estimate of $79.14 billion.

Earnings per share are expected between $29.95 and $30.65, above Wall Street’s projection of $29.90, and higher than the company’s initial estimates of $29.35 to $30.25. Lockheed’s shares gained 10.54% on Thursday to close at $568.59.

What Analysts and Hedge Funds are Doing

Wall Street did not immediately respond to the earnings call. As of the close of business on July 23, analysts have a cautious outlook on the stock, with an average upside potential of 4%. The upside percentage dropped substantially from a day earlier as investors reacted positively to the Q2 report, resulting in shares closing 10.54% higher during the day.

While the 13F filings data is awaited for Q2, institutional investors significantly increased their stake in the stock during the first quarter, with hedge fund ownership jumping 41% sequentially – from 59 funds to 83 funds, amid rising global defense budgets.

As of March 31, AQR Capital Management has the largest holding in the company, with 1,507,786 shares valued at over $911 million. Other major stakeholders include Two Sigma Advisors and D E Shaw, having holdings in excess of $815 million and $583 million, respectively.

Valuation and the Verdict

Lockheed Martin Corporation (NYSE:LMT) trades at a forward price-earnings ratio of 17.23, below the sector median of 20.97 and modestly below the company’s five-year average of 17.59, suggesting the stock is likely undervalued.

The hedge fund ownership growth coupled with a discount to sector peers sets the stock well for patient investors. Solid second-quarter results have further strengthened bullish sentiment toward LMT.

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