Defense Companies Fare Well In Gates Budget Cuts

The big story for the defense industry in the January 6 budget cuts proposed by defense secretary Robert Gates was what didn’t happen: after reducing future weapons outlays by $330 billion in previous rounds of budget cutting, this time Gates cut almost nothing. The headline story was termination of the Marine Corps Expeditionary Fighting Vehicle, but that’s mainly because nothing else of note was canceled, and even in the case of EFV Gates announced plans to develop a replacement system and modernize existing vehicles. So if you were looking for an apt metaphor to describe what happened to makers of military hardware on Thursday, you might say they “dodged the bullet.” Here’s a roundup of how the Big Six contractors fared.

BAE Systems Inc. got a shot in the arm to its beleaguered ground vehicle business with news that the venerable Amphibious Assault Vehicle will be modernized for many more years of use by the Marine Corps in ship-to-shore operations. None of the company’s key vehicle franchises was cut and its two big opportunities for the future — the Joint Light Tactical Vehicle replacement of the Humvee and the Army Ground Combat Vehicle — remain intact. In addition, BAE now has an opportunity to compete for the EFV replacement. On the electronics side, BAE may have suffered a temporary setback to its electronic warfare business from the slowing of ramp-up for the F-35 joint strike fighter, but balanced against that is the purchase of additional Boeing F/A-18 Super Hornets using BAE gear and acceleration of the Navy’s Next Generation Jammer where BAE is a strong contender. All things considered, it was a good day for BAE.

Boeing had an even better day. The latest delay in the F-35 joint strike fighter has created additional demand for its carrier-based F/A-18 Super Hornet fighter, both in the form of new airframes and in the form of refurbished planes already in the force. The acceleration of the Next Generation Jammer guarantees the company integration work on the electronic warfare version of the Super Hornet, dubbed the EA-18G Growler, even if Boeing’s team doesn’t prevail in the jammer competition. Boeing will gain additional integration work from the Air Force plan to install “advanced electronically steered array” radars on the company’s F-15 fighters, which recently got a new lease on life with announcement of a multi-billion-dollar sale to Saudi Arabia. The company will also benefit from the sale of more space launch vehicles to the Air Force and have a good shot at winning that service’s revitalized future bomber program (it has played a key role on every heavy bomber the Air Force bought for the last 50 years). The Army plan to spend more money on battlefield communications will benefit Boeing’s Ground Mobile Radio too. None of Boeing’s core franchises suffered setbacks in the Gates announcements, which is a striking reversal of fortunes from what happened to Boeing in the first round of Gates cuts in 2009.

General Dynamics took a hit to its ground vehicle business with the proposed cancellation of the Expeditionary Fighting Vehicle, but that is by no means a done deal; Marine Corps supporters on Capitol Hill are fighting mad, and may decide to buy 200 or more of the vehicles in spite of Gates. There was a lot of good news for GD in the Gates announcements too, including for its vehicle business. First, the Army will spend more money upgrading GD’s Abrams tank and Stryker armored troop carriers. Second, the Joint Light Tactical Vehicle and Ground Combat Vehicle programs where GD is very competitive remain on track. Third, the Army will spend more money on GD battlefield communications gear such as the Warfighter Information Network-Tactical and the hand-held version of the Joint Tactical Radio System. Fourth, the Navy will buy more warships, including a destroyer and new class of auxiliary vessels that GD will probably build. Every GD military franchise except the Expeditionary Fighting Vehicle fared well, and the jury is still out on that story.

Lockheed Martin suffered another delay to its F-35 joint strike fighter program, with significant impact on revenues. In addition to delaying the Marine version of the F-35 by two years, Gates reduced the pace at which Air Force and Navy versions will be bought, cutting production plans by an average of 25 planes per year over the next five years. The good news was that Gates said the Air Force and Navy variants of F-35 — which represent over 80 percent of the planned domestic production run — are performing well. Balanced against the F-35 hit to revenues is the prospect of more work for Lockheed Martin on its Aegis combat system, both in the form of an additional destroyer and in plans for European-based missile defenses. Like Boeing, Lockheed Martin will benefit from additional Air Force purchases of space launch vehicles, and it is a credible contender in the competition to build the Air Force’s future bomber. Programs that some observers thought might be cut by Gates such as the Medium Extended Air Defense System and Joint Tactical Radio System were left untouched, strengthening the outlook of Lockheed’s electronics unit. And with the Joint Light Tactical Vehicle still on track, Lockheed has an opportunity there to move into a new line of work, just as it has opened up big opportunities at home and abroad with its contract to build ten Littoral Combat Ships for the Navy. Gates confirmed on Thursday that the Littoral Combat Ship program would be robustly funded through 2015.

Northrop Grumman has been working hard to bolster investor confidence since Wes Bush took over as CEO a year ago, and there was little in the Gates announcements to impede that effort. The only significant negative was the rate cut to F-35, where Northrop contributes roughly a quarter of the value to each airframe through its aerospace and electronics units. However, the company provides a bigger portion of the F/A-18 fighter’s content, so the Navy’s plan to buy dozens of additional Super Hornets is a plus. Northrop Grumman also is well positioned to benefit from acceleration of the Next Generation Jammer. As prime contractor on the B-2 bomber, it probably will play a big role in the Air Force’s future bomber, and its electronics unit will benefit in numerous ways from service plans to upgrade vehicles and vessels. Perhaps the biggest plus in the Thursday announcements, though, was the absence of terminations in any core franchises. Some observers had thought the Block 40 version of Northrop Grumman’s high-end Global Hawk unmanned aerial system might be killed, but it appears to have escaped budget cuts intact. There was also no hint of cutbacks in military satellite programs, which play a substantial but largely unsung role in Northrop Grumman’s results.

Raytheon took some hits to its missile programs in the Gates announcements with termination of two Army programs, but the impact on results is likely to be negligible since the programs were still in development and not very big. A noteworthy plus was the announcement Air Force F-15 fighters will be upgraded with Raytheon radars. Raytheon has been a darling of Wall Street in recent years because its military electronics and missile programs are ubiquitous across the joint force. So when the defense industry suffers only modest reductions in a major round of Pentagon budget cuts, that is almost certainly good news for its biggest subcontractor. Like the other Big Six military contractors, Raytheon dodged a bullet on Thursday and has good reason to believe that it will fare similarly well in future rounds of spending reductions. It appears that policymakers have had their say on which military technology programs need to go, and now are moving on to force structure, benefits and management overhead as the key areas for future savings.